Define managerial costing.discuss its importance in managerial decision making with suitable example
Answers
When accountants prepare financial statements of past performance, they use a variety of categories for recording costs. Categories such as advertising cost, administrative costs, labor costs and many others are used that help identify the type of cost.
Marginal cost is an important factor in economic theory because a company that is looking to maximize its profits will produce up to the point where marginal cost (MC) equals marginal revenue (MR). Beyond that point, the cost of producing an additional unit will exceed the revenue generated.
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Marginal costing has different meaning under Cost accounting and Economics.
An economist will understand marginal cost as a cost of producing one additional unit at a given level of activity. The revenue gose on increasing till marginal revenue is more than marginal cost and is maximized where marginal cost equals marginal revenue.
However I presume that, the question is concerned with marginal costing as considered under cost accounting.
Under Cost accounting, marginal cost is variable cost of producing one Unit at a given capacity level. Here it is important to bifurcated all costs into variable and fixed cost. There may also be semi variable or semi fixed elements of cost. The first and foremost activity under marginal costing is to bifurcated all costs including semi variable ones into fixed and variable cost. We should be able to make a cost function as
TC= FC+n×VC
Where
TC=Total Cost
FC= Fixed Coat
n= number of units, and
VC= Variable cost or MARGINAL COST.
let us discuss two more terms before proceeding further,
Contribution is defined as selling price
-variable cost
Total contribution =
Total sales that is n×SP (SELLING PRICE)- TOTAL VARIABLE COST (that is n× variable cost)
Contribution per unit= SELLING PRICE PER UNIT VARIABLE COST PER UNIT.
PV RATIO= COTNTRIBUTION PER UNIT / SELLING PRICE PER UNIT.
Having understood these concepts, let us see the use of marginal cost principle. It is a very vast area, and it is not possible to include entire gamut of applications of marginal costing, but the main applications are given below.
Determination ofBreak Even Point (BEP)
BEP is a point where there is no profit or loss. In other words it is the minimum level of output that must be achieved in order to recover all costs without earning any profit.
BEP in number of Units =Fixed Cost/ contribution per unit
BEP in value = Fixed cost/ PV ratio.
This way a firm can determine the minimum level of output to avoid any loss.
2. Activity Level to earn a given profit.
Suppose, a firm wishes to earn a particular profit say P1.
Now applying the above principle,
Sale volume to achieve profit P1= (
FC+P1)/Contribution per unit
Sales Value= (FC+P1)/ PV RATIO.
3. Determining optimum selling price.
Where there are market reports that different sales volumes can be achieved at different prices, that is higher volume at lower prices, we have to analyze and find out at what level CONTRIBUTION is MAXIMIZED.
4. Product Mix. When there are multiple products, we have to produce maximum those products which have higher contribution per unit subject to constraints of demand and production capacity.
5. Utilization of spare capacity. If there is spare capacity, we can take up any additional or product where its price is higher than marginal cost.
These are some of the main application of marginal costing.
Limitation: there are two major limitations.
Bifurcation of cost into fixed and variable is in practice, difficult to achieve. It is generally not possible to formulate a linear cost function without some adjustments.
In the long run, capacity can be modified depending upon market situation. this will change the cost function. To make meaningful applications, This aspect needs to be incorporated in decision making.