Page 256 - DMGT403_ACCOUNTING_FOR_MANAGERS
P. 256
Unit 12: Marginal Costing and Profit Planning
Notes
Fixed Production O/H incurred (xxxx)
(Under)/Over Absorption xxxxx
Adjusted Profit xxxxx
Limitations of Absorption Costing
The following are the limitations of absorption costing:
1. In absorption costing, a portion of fixed cost is carried over to the subsequent accounting
period as part of closing stock which is an unsound practice because costs pertaining to a
period should not be allowed to be vitiated by the inclusion of costs pertaining to the
previous period and vice-versa.
2. Absorption costing is dependent on the levels of output which may vary from period to
period, and consequently cost per unit changes due to the existence of fixed overhead.
Unless fixed overhead rate is based on normal capacity, such changed costs are not helpful
for the purposes of comparison and control.
3. The cost to produce an extra unit is variable production cost. It is realistic to the value of
closing stock items as this is a directly attributable cost. The size of total contribution
varies directly with sales volume at a constant rate per unit. For the decision-making
purpose of management, better information about expected profit is obtained from the
use of variable costs and contribution approach in the accounting system.
12.2 Marginal Costing and Direct Costing
According to ICMA, London, “Marginal cost is the amount at any given volume of output, by
which aggregate costs are charged, if the volume of output is increased or decreased by one
unit.”
Marginal cost is the cost nothing but a change occurred in the total cost due to changes taken
place on the level of production i.e either an increase/decrease by one unit of product.
Example: The firm XYZ Ltd. incurs 1000 for the production of 100 units at one level of
operation. By increasing only one unit of product i.e. 101 units, the firm’s total cost of production
amounted 1010.
Total cost of production at first instance (C’) = 1000
Total cost of production at second instance (C”) = 1010
Total number of units during the first instance (U’) = 100
Total number of units during the second instance (U”) = 101
Increase in the level of production and Cost of production:
Change in the level of production in units = U”-U’= DU
Change in the total cost of production = C”– C’= DC
Change (Increase) in the Total Cost of Production ΔC 10
Marginal Cost = = = = 10
Change (Increase) in the Level of Production ΔU 1
LOVELY PROFESSIONAL UNIVERSITY 251
