Friday, May 29, 2009

Costing Techniques , how these are useful in decision making?

Discuss the Costing Techniques that are being used in your organization or any other organization of your choice and also write in brief as to how these are useful in decision making?

Costing Techniques
1. Uniform Costing
2. Marginal Costing
3. Standard Costing
4. Historical Costing
5. Direct Costing.
6. Absorption Costing

I am familiar with Parle products. Today, Parle enjoys a 40% share of the total biscuit market and a 15% share of the total confectionary market, in India. Parle Products has one factory at Mumbai that manufactures biscuits & confectioneries while another factory at Bahadurgarh, in Haryana manufactures biscuits. Apart from this, Parle has manufacturing facilities at Neemrana, in Rajasthan and at Bangalore in Karnataka.

Marginal Costing is being used in our organization.
Marginal costing is not a system of costing like job costing, process costing, operating costing, etc. but a special technique used for managerial decision making. The technique of marginal costing is used to provide a basis for the interpretation of cost data to measure the profitability of different products, processes and cost centres in the course of decision making. It can, therefore, be used in conjunction with the different methods of costing such as job costing, process costing, etc. or even with other techniques such as standard costing or budgetary control.

In marginal costing, cost ascertainment is made on the basis of the nature of cost. It gives consideration to behaviour of costs. In other words, the technique has developed from a particular conception and expression of the nature and behaviour of costs and their effect upon the profitability of an understanding.

Theory of Marginal costing:
The theory of marginal costing may therefore be explained in three steps:
(i) The volume of output increases, the cost per unit will, in the normal circumstances, be reduced. Conversely, if the output is reduced the cost per unit will go up. If the factory produces 1,000 units at a total cost of Rs. 3, 000 and if by increasing the output by one unit the cost goes upto Rs. 3,002, therefore the marginal cost of the additional output is Rs. 2.
(ii) If the increase in output is more than one, the total increase in cost divided by the total increase in output will give the average marginal cost per unit. If, for example, the output is increased to 1,020 units and the total cost to produce these units is Rs. 1,045 the average marginal cost per unit is Rs. 2.25 per unit as under:
Additional cost = Rs. 45 = Rs 2.25
Additional units 20
(iii) The ascertainment of marginal cost is based on the classification and segregation of costs into fixed and variable costs.

Advantages and limitations of Marginal Costing:
1. The marginal cost remains constant per unit of output whereas the fixed cost remains constant in total. Since marginal cost per unit is constant from period to period within a short span of time firm decisions on pricing policy can be taken. If fixed cost is included, the unit cost will change from day to day depending upon the volume of output. This will make decisions making task difficult.
2. Overheads are recovered in marginal costing on the basis of pre-determined rates. If fixed overheads are included on the basis of pre-determined rates, there will be under-recovery of overheads if production is less or if overheads are more. There will be over-recovery of overheads if production is more than the budget or actual expenses are less than the estimate. This creates the problem of treatment of such under or over-recovery. Marginal costing avoids such under or over-recovery of overheads.
3. Advocates of marginal costing argue that under the marginal costing technique, the stock of finished goods and work in progress are carried on marginal cost basis and the fixed expenses are written off to profit and loss account as period costs. This shows the true profit of the period.
4. Marginal costing helps in carrying out break-even analysis that shows the effect of increasing or decreasing production activity on the profitability of the company.
5. Segregation of expenses as fixed and variable helps the management that shows the effect of increasing or decreasing production activity on the profitability of the company.
6. Managerial costing helps the management in taking a number of business decisions like make or buy, discontinuance of a particular product, replacement of machines, etc.

1. It is difficult to classify costs exactly into fixed and variable. Most of the expenses are neither totally variable nor wholly fixed.
2. Contribution itself is not guide unless it is linked with the key factor.
3. Sales staff may mistake marginal cost for total cost and sell at a price, which will result in loss or low profits. Hence, sales staff should be cautioned while giving marginal cost.
4. Overheads of fixed nature cannot altogether be excluded particularly in large contracts while valuing the work-in-progress. In order to show the correct position fixed over heads should be included in work-in-progress.
5. Some of the assumptions regarding the behaviour of various costs, etc. are not necessarily true in the realistic situation. For example, the assumption that fixed cost will remain static throughout is not correct.

The technique of Marginal Costing is of immense use to the management in taking various decisions, as explained below:
Helps in determining the volume of production: Marginal cost helps in determining the level of output which is most profitable for a running concern. The production capacity, therefore, therefore, can be utilized to the maximum possible extent. It helps in determining the most profitable relationship between cost, price and volume in the business which helps the management in fixing best selling price for its products. Thus, maximization of profit can be achieved.
Helps in selecting production lines: The technique of Marginal Costing helps in determining the most profitable production line by comparing line by comparing the profitability of different products. Certain products or activities may turn out to be unprofitable with the passage of time. Production of such products can be discontinued while production of those products and work as a good guide for deciding the optimum mix of products keeping in mind the available capacity and resources.
Helps in deciding whether to produce or procure: The decision whether a particular product should be manufactured in the factory or procured from outside source can be taken by comparing the price at which it can be had from outside. In case the procurement price is lower than the marginal cost of production, it will be advisable to procure the product from outside rather than manufacture it in the factory.
Helps in deciding method of manufacturing: In case a product can be manufactured by two or more methods, ascertaining the marginal cost of manufacturing the product by each method will be helpful in deciding as to which should be adopted.
Helps in deciding whether to shut down or continue: Marginal costing, particularly in periods of trade depression, helps in deciding whether the production in the plant should be suspended temporarily in spite of low demand for the firm’s products.


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