Page 92 - DCOM206_COST_ACCOUNTING_II

Unit 5: Differential Costing

the revenues and cost differences between alternatives. While marginal costing analyses the Notes
change in only the variable costs differentia costing examines the differences in both variable
and fined costs. Hence this technique is more useful for those situations where fixed costs also
differ and thus more appropriate for both short run and long, run decisions.
Differential costs are costs that change in respect of an alternate course of action. The AAA
Committee on cost concepts and standards (Accounting Review, Vol. 27) defines it as -the increase
or decrease in total cost or the change in specific elements of cost that result from any variations
in operation”. The alternative actions may owe to change in sales, volume, price, product mix,
or methods of production or change in decision. When two revels of activity are under review,
differential cost is obtained by deducting the cost at one level from another.

Example: If the work is done in machine the cost is ` 2,55,000, if the work is done with
the labour the cost will be ` 2,00,000, the differential cost is ` 55,000.
The technique used for analysing differential costs is known as differential costing. The ICMA
terminology defines differential costing as “a technique used in the preparation of ad hoc
information in which only cost and income, difference between alternative courses of action are
taken into consideration.”
It is the process of determining how costs in particular and profit in general will be affected if
one alternative is chosen over another. The term “incremental cost” is used to denote differential
cost when the increase in cost in due to increase in the level of production. Similarly, the term
decremental cost is used when the difference in cost is due to decrease in the level of production.

Did u know? What is said of the differential cost above, applies to differential revenue
also.

5.1.1 Features of Differential Costing

The features of differential costing can be enumerated under the following points:

(a) It is expressed in total but not cost per unit.
(b) The data considered for such analysis are (i) cost, (ii) revenue and investment which are
relevant to the problem under consideration.

(c) It is not a part of accounting though it is a form of budgeting. It is used only by the
management to make decisions.
(d) The constant costs at different levels are ignored and only the differentials are considered.
Absolute cost is not much importance in this analysis.
(e) Differentials are measured from a common position or level of activity.
(f) Where the difference between revenue and cost is highest, that course of action is adopted.

Note The differential costing is based on the implication that only the relevant cost,
which will change as a result of the decision, is useful for decision-making. Any costs
which are not expected to alter are irrelevant for decision-making.

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