Page 260 - DMGT403_ACCOUNTING_FOR_MANAGERS

Unit 12: Marginal Costing and Profit Planning

(ii) When output is less than sales i.e., closing stock is less than opening stock, the profit under Notes
marginal costing is greater than the profit under absorption costing;
(iii) When output is greater than sales i.e., closing stock is more than the opening stock, the
profit under the marginal costing is less than the profit under absorption costing.

12.3 Differential Costing

Differential cost is the difference in the total cost that will arise from the selection of one
alternative instead of another. The alternate choice may arise on account of change in the method
of production, sales volume, product mix, price, selection of an additional sales channel, make
or buy decisions, etc.

Characteristics of Differential Costing

The following are the key characteristics of differential costing:
1. In order to ascertain the differential costs, only total cost is needed and not cost per unit.
2. Existing level is taken to be the base for comparison with some future or forecasted level.
3. Differential cost is the economist’s concept of marginal cost.

4. It may be referred to as incremental cost when the difference in cost is due to increase in
the level of production and decremental costs when difference in cost is due to decrease in
the level of production.
5. It does not form part of the accounting records, but may be incorporated in budgets.
6. It is not necessary to adopt marginal cost technique for differential cost analysis because it
can be worked out on the method of absorption costing or standing costing.
7. What is said of the differential cost above, applies to differential revenue also.

Example: Make or Buy Decision
Suppose a manufacturing company incurs the following costs with respect to producing a product
“A” (5000 units)
Materials 500,000
Labor 250,000
Overheads 200,000
Indirect expenses 150,000

Total expenses 1,100,000
Suppose the same product “A” is available from an outsider at 200 per unit, the company will
decide to buy rather than to make because buying will cost the company only 1,000,000, which
is lower than the cost of production.

12.4 Costs-Volume Profit Analysis

The Cost-Volume-Profit (CVP) analysis helps management in finding out the relationship of
costs and revenues to profit. The aim of an undertaking is to earn profit. Profit depends upon a
large number of factors, the most important of which are the costs of the manufacturer and the
volume of sales effected. Both these factors are interdependent – volume of sales depends upon

LOVELY PROFESSIONAL UNIVERSITY 255