Marginal Costing as an Essential Tool for Decision Making



Marginal Costing as an Essential Tool for Decision Making

The concept of marginal costing was adopted from the economist concept of marginal costs. It has employed in the early part of this century, particularly by the famous economist Alfred Marshall. The concept is known as the addition or incremental cost of producing extra one unit of a product. When accountants begin to employ the term “ marginal cost” the idea was extended to corner not only the difference in cost resulting from the increase or decrease in the output which is the marginal cost.

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In practice however, marginal cost is taken to mean the total of all the cost, which vary with variation in output that is the variable cost. Accordingly, marginal cost, variable cost and direct cost are used interchangeably.

Wheldon’s cost accounting defines marginal costing as a special technique concerned particularly with the effect which fixed overhead has on the running a business.

Batty J. in his view on the subject opines that marginal costing is a technique which classifies cost into two categories, those which are fixed and the other which varies, so that the effect of change in volume of output can be evaluated in terms of costs, contributions and possible profit.

Lucey T. in his own contribution sees marginal costing as distinguishing between fixed cost and variable costs. This however agrees with the earlier definitions. He want further to outline the components of marginal cost as including direct material, direct labour, direct expenses and the variable part of overheads. He finally defined marginal costing as “A costing technique/ principle whereby variable costs are charged to cost units and the fixed cost attributable to the relevant period are written off in full against the contribution for that period”.

Owler and Brown in their own contribution on the subject, see marginal costing as not being a system of costing rather as a special technique of cost accounting concerned particularly with the effects fixed overhead has on the running of a business enterprises.

Owler and Brown’s contribution agree with Weldon’s and Batty is contributions that marginal costing is not a system of costing like job and presses costing rather it is super –imposed upon the costing systems. Batty T. went further to attempt its definition as “A technique of cost accounting, which lays specials attention to the behaviour of cost with changes in volume of output”.

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Bigg W. Walter in his view sees marginal costing not as a system of cost ascertainment on the same lines as job, operating or process costing, but is rather a technique to deal with the effect on profits of changes in volume or type of output. He went further to explain that “fixed” have is used to mean that expenses so classified are fixed only in relation to production, they are by no means “fixed” in relation to time, and in fact they tend to vary in relation to the length of the period covered.

Institute of Cost and Works Accountants (ICWA) defined marginal cost as the amount at any given volume of output by which aggregate cost are changed if the volume of output is increased by one unit.

Horngreen T.C. is of the view that marginal costing apply to the variable production cost to the cost of production costing, because fixed manufacturing overhead is regarded as a period cost rather than as product cost.

Lester Heigter and Serge Matiwch view it from the economist’s perspective rather than the accountant’s perspective when they said that “ marginal costing is the amount of cost increase caused by a unit increase in output in that means that their definition aggress with that of Institute of Cost and Works Accountants (ICWA) by viewing it as an economist.

Babbot T. in his cost and Management Accounting also agrees with the view expressed by Lester and Serge, ICWA; when he said that “Marginal Costing is the amount of any given volume of output by which aggregate costs are changed if the volume of output is increased or decreased by output unit”.

Pickles and Lafferty, in their view opined, “Marginal Costing is a method whereby fixed costs, which are related to time and not to production are excluded from cost comparisons”.

Walter Meigs and Robert Fim in their own view gave a very concise definition of the subject, which is all embracing when then they said that “variable cost are cost that vary proportionately with volume of output”.

Furthermore, Harper in his view opined, “A Marginal Cost is the variable cost incurred as a result of undertaking a specified activity. It is clearly composed, in the main, of direct material costs, direct labour costs, direct expenses and variable overheads”. He further stressed that a strict line of demarcation cannot be drawn between marginal cost, variable cost and direct cost. They are often regarded as miter-changeable.

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It is therefore clear from the accountants view that marginal costing concept that the marginal cost per unit remains unchanged regardless of the levels of activity. The marginal cost of a unit of production will involved the direct material, labour and expenses to make that unit, and since each unit will require the same regardless of the number of units produced. For example if a chair cost N 700 to product and made up of   N 350 of material and N 350 of labour, then a second chair will equally cost N 700 that is the marginal cost per unit of product remain constant assuming that material and labour are the only marginal costs incurred in the production.

In the final analysis, it is important to note that the fact that all the above contributors have defined the subject matter without incorporating in their definitions the use to which the concept of marginal costing be put, this researcher therefore is obliged to attempt a definition embodying the use to which this all important technique or concept can be used for the purpose of a general conceptualization.

Marginal costing can therefore be defined as an accounting technique used by management in planning controlling, and in decision-making, which based its analysis of cost, volume and profit relationship on a determination of marginal cost (variable cost0 by a process of differentiation between fixed cost and variable costs.

The fact that the latter definition emphasis the use, of which marginal costing principles can be put, does not mean that the various views of the authorizes on the subject matter of this study is of no effect but that the latter definition reveals, at a glance, what the concept of marginal costing in all about and why it is studied.

2.2     THE PRINCIPLES OF MARGINAL COSTING

(a)     Since fixed or period cost is the same, irrespective of the volume of production or sale, provided the level of activity is within a relevant range, it follows that by selling an extra item of product or service:

  1. Revenue will increase by the sales value of the product sold
  2. Cost will increase only by the variable cost per unit.

iii.      Therefore the increase in profit will equal the sales value less variable cost of the product, that is the amount of contribution carried from the sales of the item.

(b)     Similarity if the volume of sale falls by one item, the profit will fall by the amount of contribution eared from the item.                    

(c)      Profit measurement should therefore be based on an analysis of total contribution. Since fixed cost relates to a period of time, and do not change with increase or decrease in sales volume, it is misleading to charge units of sales with a share of fixed costs. Absorption costing is therefore misleading, since it is more appropriate to deduct fixed cost from total contribution for the period to derive a profit figure.

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(d)     Where a unit of product is made, the extra cost incurred in its manufacture is the variable production cost. Fixed cost is unaffected and no extra fixed cost is incurred when the output is increased. It is therefore agreed that the valuation of closing stocks should be at production variable cost (direct material, direct labour, direct expenses if any and variable production overhead) because these are the only costs properly attributable to the products.

Before explaining marginal costing principles any further, it will be helpful to illustrate using a numerical example.

Example

CNC Nwekeson limited produces a product, called ‘bisco’, which has a variable production cost price of N 6.00 per unit and the sale price is N 10.00 per unit. At the beginning of September, there was no opening stock and production during the month was 2000 units. Fixed cost to the month was N 45.00 (including, administration, dales and distribution. There was no variable marketing cost.

—-This article is not complete———–This article is not complete————

This article was extracted from a Project Research Work Topic

“MARGINAL COSTING AS AN ESSENTIAL TOOL FOR DECISION MAKING IN A MANUFACTURING COMPANY ”

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