MARGINAL COSTING AS A TECHNIQUE OF DECISION

MAKING
CHAPTER 1
1. INTRODUCTION
Marginal Costing is not a distinct method of costing like job costing, process costing,
operating costing, etc., but a special technique used for management decision making.
Marginal costing is used to provide a basis for the interpretation of cost data to measure
the profitability of different products/ Processes and costs centres in the course of decision
making. It can therefore be used in conjunction with the different methods of costing such
as standard costing or budgetary control.
In marginal costing, cost ascertainment is made on the basis of the nature of control. 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 cost and their
effect upon the profitability of an undertaking.
In the orthodox or total cost method, as opposed to marginal costing method, the
classification of costs is based on functional basis. Under this method the total cost is the
sum of the cost direct material, direct labour. Direct expense, manufacturing overheads,
administrating overheads, selling and distribution overheads. In this system other things
being equal, the total cost per unit will remain constant only when the level of output or
mixture is the same from period to period. Since these factors are continually fluctuating,
the actual total cost will vary from one period to another. Thus it is possible for the
costing department to say one day that an item cost Rs. 20 and the next day it costs Rs.
18.This situation arises because of changes in volume of output and the peculiar
behaviour of fixed expense included in the total cost. Such fluctuating manufacturing
activity and consequently the variations in the total cost from period to period or even
from day to day, poses a serious problem to the management in taking sound decisions.
Hence the application of marginal costing has been wide recognition in the field of
decision making.

1.1 CHARACTERISTICS OF MARGINAL COSTING

The technique of marginal costing is based on the distinction between product costs and
period costs. Only the variables costs are regarded as the costs of the product while the
fixed costs are treated as period costs which will be incurred during the period regardless
of the volume of output. The main characteristics of marginal costing are as follows:

All elements of costs are classified into fixed and variable components. Semi-

variable costs are also analysed into fixed and the variable elements.
The marginal or variable costs (as direct material, direct labour, direct expenses)

are treated as the cost of product.

Under marginal costing, the value of finished goods and work-in-progress is also
comprised only of marginal costs. Variable selling and distribution are excluded
for valuing these inventories. Fixed costs are not considered for valuation of

closing stock or finished goods and closing WIP.

Fixed cost are treated as period costs and is charged to profit and loss account

for the period for which they are incurred.

Prices are determined with reference to marginal costs and contribution margin.
Profitability of departments and products is determined with reference to their
contribution margin.

1.2 DEFINITIONS

1.3 ADVANTAGES OF MARGINAL COSTING

Marginal costing is simple to understand.

By not charging fixed overhead to cost of production, the effect of varying charges

per unit is avoided.

It prevents the illogical carry forward in stock valuation of some proportionof

current years fixed overhead.

The effects of alternative sales or production policies can be more readily
available and assessed, and decisions taken would yield the maximum return to

business.
It eliminates large balances left in overhead control accounts which indicate the

difficulty of ascertaining an accurate overhead recovery rate.

Practical cost control is greatly facilitated. By avoiding arbitrary allocation of
fixed overhead, efforts can be concentrated on maintaining a uniform and

consistent marginal cost. It is useful to various levels of management.

It helps in short-term profit planning by breakeven and profitability analysis, both
in terms of quantity and graphs. Comparative profitability and performance
between two or more products and divisions can easily be assessed and brought to
the notice of management for decision making.

1.4 DISADVANTAGES OF MARGINAL COSTING

The separation of costs into fixed and variable is difficult and sometimes gives

misleading results.
Normal costing systems also apply overhead under normal operating volume and

this shows that no advantage is gained by marginal costing.

Under marginal costing, stocks and work in progress are understated. The
exclusion of fixed costs from inventories affect profit and true and fair view of

financial affairs of an organization may not be clearly transparent.

Volume variance in standard costing also discloses the effect of fluctuating out put
on fixed overhead. Marginal cost data becomes unrealistic in case of highly

fluctuating levels of production, e.g., in case of seasonal factories.

Application of fixed overhead depends on estimates and not on the actual and as

such there may be under or over absorption of the same.

Control affected by means of budgetary control is also accepted by many. In order
to know the net profit, we should not be satisfied with contribution and hence,
fixed overhead is also a valuable item. A system which ignores fixed costs is less
effective since a major portion of fixed cost is not taken care of under marginal

costing.
In practice, sales price, fixed cost and variable cost per unit may vary. Thus, the
assumptions underlying the theory of marginal costing sometimes becomes

unrealistic. For long term profit planning, absorption costing is the only answer.
Marginal costing assumes that all costs can be classified into fixed and variables.

But there may be certain costs which are neither fixed nor variable.
The application of marginal costing in certain industries such as ship building,
construction, etc. may show no profit or loss during the year work is in progress,
but huge profit in the year the work is completed. This is due to non-inclusion of

overheads in the value of closing work-in-progress.

In the long run, true selling price should be based on total cost i.e., inclusive of
fixed cost also. In the short run or in special situations when a product is sold
below the total cost, customers may insist on the continuation of reduced prices
forever and this may not be possible in all cases.

CHAPTER 2

BIBLIOGRAPHY
Books:

Cost Accounting and Financial Management: 2001

Samir Kumar Chakravarty
New Age International Pvt.Ltd.

Advanced Cost Accounting, 1987

B.M. Lall, Nigam
Himalaya Publications.

Sites:

Wikipedia
http://en.wikipedia.org/wiki/marginal_cost
Google
http://www.google.com/
www.accountingcoach.com
http://www.referenceforbusiness.com/encyclopedia/oil-per/costingmethods.html

OPERATING COSTING AND ITS APPLICATION

CHAPTER 1
INTRODUCTION TO TOPIC
1. INTRODUCTION

It is a method of costing applied by undertakings which provide service rather

than production of commodities. Like unit costing and process costing, operating
costing is thus a form of operation costing. The emphasis under operating costing is
on the ascertainment of cost of rendering services rather than on the cost of
manufacturing a product. It is applied by transport companies, gas and water works,
electricity supply companies, canteens, hospitals, theatres school etc. Within an
organisation itself certain departments too are known as service departments
which provide ancillary services to the production departments. E.g. Maintenance
department, power house, boiler house, canteen, hospital, internal transport. The
information concerning the business enterprise is very helpful to the management to
control it in an efficiently way. As the other branches like financial accountancy and
management accountancy, the cost accountancy also serves the important information
to the management regarding the operating efficiency of the business. It becomes very
easy for management to lay down management policies, to guide management
decisions or evaluate operating management performance with the information
provided by cost accounting. The term operation in business terminology refers to an
activity of the business. It is very important to study the operations of the business in
detail because depends on the operations, which it performs. The management should
always concentrate on the efficiency of the operation and also the costs associated to
the operations. It is very important to control the costs associated to the operations for
the enterprises like manufacturing companies, companies engaged in the process of
extraction of materials from earth like, coal mines etc.

1.2 ESSEENTIAL FEATURES OF OPERATING COST

1) The operating costs can be classified under three categories. For example
in the case of transport undertaking these three categories are as follows:
a) Operating and running charges-It includes expenses of variable nature. For example
expenses on petrol, diesel, lubricating oil, and grease etc.
b) Maintenance charges-These expenses are of semi-variable nature and include the
cost of tyres and tubes, repairs and maintenance, spares and accessories, overhaul,
etc.

c) Fixed or standing charges-These includes garage rent, insurance, road licence,

depreciation, interest on capital, salary of operating manager, etc.
2) The cost unit used is a double unit like passenger-mile; Kilowatt-hour,
etc. It can be implemented in all firms of transport, airlines, bus-service,
etc., and by all firms of Distribution Undertakings.

FEATURES OF COST ACCOUNTING:1. It is a process of accounting for costs.

2. It records income and expenditure relating to goods and services.
3. It provides statistical data on the basis of which future estimates are prepared and
quotations are submitted.
4. It is concerned with cost ascertainment, cost control and cost reduction.
5. Finally it involves the preparation of right information to the right person at the
right time so that it may be helpful to management for planning, evaluation of
performance, control and decision-making.

1.3 ADVANTAGES OF COST ACCOUNTANCY

1. It enables a concern to measure the efficiency and than to maintain and
improve it. This can be done with the help of comparison of data made
available of the previous periods and current period.
2. It provides information upon which estimates and tenders are based.
3. It guides for future production polices. It explains the cost incurred and
there by provides data on the basis of which production can be
appropriately planned.
4. The extract cause of decrease or increase in profit/loss can be detected. A
concern may suffer not because of the cost of production is high or prices

are low but also because the output is much below the capacity of the
concern.
5. Efficiency of public enterprises. Costing has a more important role to
play in public enterprises than in private enterprises. The primary
objective of the public enterprises is not to raise profits but it is to serve
the society by providing quality good at cheaper rates.

CHAPTER 2
OPERATING COSTING: A BRIEF REVIEW
It is defined as the refinement of process costing. It is concerned with the determination of
the cost of each operation rather than the process. In those industries where a process
consists of distinct operations, the method of costing applied or used is called operation
costing. Operation costing offers better scope for control. It facilitates the computation of
unit operation cost at the end of each operation by dividing the total operation cost by

total input units. The two costing methods included under this head are process costing
and service costing.

1.1 PREPARATION OF COST SHEET UNDER OPERATING COST

For preparing a cost sheet under operating cost, costs are usually accumulated for a
specified period viz., a month, a quarter, or a year etc. All of the accumulated costs
should be classified under the following three heads:
1. Fixed costs or standing charges- Which are the same whether the operation is
closed or running at 100% capacity. Fixed Costs include items such as the rent of the
building. These generally have to be paid regardless of what state the business is in.
2. Variable costs or running charges- Which may increase depending on whether
more production is done, and how it is. Variable Costs include indirect overhead costs
such as Cell Phone Services, Computer Supplies, Credit Card Processing, Electrical
use, Janitorial Supplies, Office Products, Payroll Services, Telecom, Uniforms,
Utilities, or Waste Disposal etc.
3. Semi-variable costs or maintenance costs- Under operating costing, the per unit
cost of service may be calculated by dividing the total cost for the period by the total
units of service in the period.
Overhead costs for a business are the cost of resources used by an organization just
to maintain its existence. Overhead costs are usually measured in monetary terms, but
non-monetary overhead is possible in the form of time required to accomplish tasks.
Examples of overhead costs include:
payment of rent on the office space a business occupies
cost of electricity for the office lights
some office personnel wages
Non-overhead costs are incremental costs, such as the cost of raw materials used
in the goods a business sells. Operating Cost is calculated by Cost of goods sold +
Operating Expenses. Operating Expenses consist of:
Administrative and office expenses like rent, salaries, to staff, insurance,

directors fees etc.

Selling and distribution expenses like advertisement, salaries of salesmen. It

includes all operating cost such as salary, rent, stationery, furniture etc.
In the case of a device, component, piece of equipment or facility, it is the
regular, usual and customary recurring costs of operating the equipment. This does
not include the capital cost of constructing or purchasing the equipment. Operating
costs are incurred by all equipment.
Equipment operating costs may include:

Salaries or Wages of personnel

Advertising
Raw materials
License or equivalent fees (such as Corporation yearly registration fees)

a.
b.
c.
d.

imposed by a government
Real estate expenses, including
Rent or Lease payments.
Office space rent
furniture and equipment
investment value of the funds used to purchase the land, if it is owned instead

of rented or leased
e. property taxes and equivalent assessments
f. Operations taxes, such as fees assessed on transportation carriers for use of

highways
Fuel costs such as power for operations, fuel for production
Public Utilities such as telephone service, Internet connectivity, etc.
Maintenance of equipment
Office supplies and consumables
Insurance premium
Depreciation of equipment and eventual replacement costs (unless the facility has

no moving parts it probably will wear out eventually)

Damage due to uninsured losses, accident, sabotage, negligence, terrorism and

routine wear and tear.

Taxes on production or operation (such as subsidence fees imposed on oil wells)
Income taxes.

1.2 EXAMPLES OF COST UNIT FOR SERVICES

1.
2.
3.
4.
5.
6.
7.

Transport Ton- Kilometre, Passenger KM, KM Travelled.

Hotel Bed- nights available, occupied, meals.
College/Schools- Students hours, full time/part time student hours.
Hospitals- Patient bed days, occupied, per operation, per visit.
Electricity Kilowatt-hours
Swimming pool- Bathers attended, Hours of opening.
Canteen- Meals provided, Ingredients of Dishes.

CHAPTER 3

MAIN AREAS OF OPERATING COSTING

Operating costing is further divided in and used in 3 main areas namely
1. Hotel industry
2. Hospital industry &
3. Transport industry

1. HOTEL INDUSTRY
In the hotel industry, expenses are divided into two main categories:
a. Direct Expenses: These are the expenses that vary with the level of
production. For example, in the Food and Beverage department, the Cost
of Food Sales is a direct expense. For, the more dishes we serve, the more
cost of Food Sales the Hotel incurs. Moreover, in the Telephone
Department, the Cost of Calls is a direct expense. For, the more we connect
guests to whatever destination wanted, the more cost of calls the hotel
incurs.
b. Indirect Expenses: These are the expenses that do not vary with the level
of production, or variable costs that cannot be feasibly distributed to
various Financial Reporting Centres. In the hotel industry, indirect
expenses are, hence, divided into two different categories:
Fixed Charges- Examples might include rent, insurance, property
taxes, and interest expense. For, these very expenses are incurred
for the benefit of the hotel as a whole not for the benefit of each
single department. To illustrate, if a hotel insures itself against fire,
theft and burglary, and one day some valuable equipment has been
stolen, from any department whatsoever, the insurance company

will indemnify the hotel.

Undistributed Expenses- Examples might include electricity,
energy, and water expenses. For, usually the hotel receives a total
energy bill to be paid. In the old days, some hotels went for
allocating this amount according to certain factors. However, this
practice proved to be misleading, since it might under-allocate
energy expenses for some departments and over-allocate it for
others. Nowadays, most of the hotels decide not to allocate such
expenses any more. Rather, hotels report such expenses in separate
schedules.

2. HOSPITAL INDUSTRY
Hospital cost information is derived by relating the inputs of resources in monetary terms
to the outputs of services provided by the hospital. Cost information is part of the basic
information needed by managers and policy makers for making decisions about how to
improve the performance of a hospital, where to allocate the resources within or among
hospitals, or to compare the performance of different hospitals to one another. Some of
the basic reasons for wanting cost information are to improve efficiency, increase
effectiveness, enhance sustainability, and improve quality.
Information on the costs and outputs of hospitals can provide considerable information for
managers of hospitals, regional coordinators of health services, and policy makers
overseeing the issues of the national health system. The information can be used to assess
the internal operations and performance of a single hospital such as helping assess the
utilization of health personnel in different departments of the hospital in providing
services and to make comparisons of the operations and efficiency of different hospitals.
Some of the specific potential uses of cost information for a health care administrator are:

Comparison across facilities to identify those that are efficient from those are not,
comparison of costs with fees,
development of a cross-subsidization strategy,
evaluation of the financial requirements of a new program, or
Analysis of the effect of changing the use of staff, equipment, and supplies in
providing services in an existing program.

PROCESS OF DETERMINING COST IN HOTEL INDUSTRY:

1. Defining the major and relevant activity areas of the hospital
1. Inpatient:
Medical ward
Surgical ward
Maternity
Private ward
2. Outpatient clinic
3. Ancillary services
Pharmacy
Laboratory
Radiology (X-Ray)
4. Outreach services (services provided off-site: mobile MCH clinics, patrols, etc.)
5. Training school

2. Gathering information on the services provided or the output of the hospital

Information to be gathered for each of these areas will be based on a typical measure of
workload. For inpatient services two outputs are sought: total inpatient days and total
admissions. The reason for two measures is that since these measures will serve as a
denominator and determine the outputs of this model, it is often useful to have not only
the unit cost per day of hospitalization (total costs/total patient days) but also to have the
average cost per admission (total costs/total admissions). This latter output of the model
total cost per admission is especially helpful if attempting to determine the payments or
premiums on a capitation basis.
3. Determining the labour and other recurrent costs
The major components of expenditure are detailed below
Recurrent costs:

Labour
Salaries
Allowances (uniforms, housing, education, home leave, rural or hardship

incentive pay, etc.)

Free .Their services should be costed as the equivalent of what a national

would receive for doing that same job.

Drugs
Medical Supplies
Transportation (petrol and maintenance for vehicles and ambulances)
Maintenance (for all facilities and equipment other than vehicles)
Food (total food costs incurred for both patients and staff)
Telecommunications
Office expenses
Other

4. Ascertaining the capital costs of the hospital

Building: (construction or modification but not routine maintenance, which is

included in recurrent costs)

Equipment: (major equipment purchased for the facility). Equipment is
considered capital equipment if its cost is higher than some set amount (such as
US$ 200) and it has an expected useful life of more than one year. If it does not

meet these requirements then it is a recurrent cost. For example, waste cans have
a useful life of greater than one year but because they cost much less than $200

their purchase is considered a recurrent rather than a capital cost.

Vehicles.

5. Allocating the indirect costs

The model includes a summary chart, constructed from the labour and the other costs
listed, which lists the total cost for each activity area. Because we also want the
Unit costs of those areas providing patient care services, the indirect or administrative
costs must be allocated to the inpatient, outpatient, other ancillary services, and any other
activities as defined in the first step.
The administrative costs are considered indirect in that they support the care and
ancillary services delivered to patients and are part of the total costs of the facility. To
allocate these indirect costs of administration we must use what is termed the step
-down allocation
method.
6. Reviewing and using the hospital cost summary
The resulting information can be used by an individual institution or for comparing
several institutions. The uses, as mentioned in the introduction, include:
1. Accountability- Using the information to report to the hospital board or the
ministry how financial resources have been used, and that they have been used
properly and efficiently. Budgets may be generated using cost information.
2. Assessing efficiency- Efficiency is achieved when more hospital services
(outputs) are produced with the same amount of resources (staff, finances,
equipment) or when the same output is produced with fewer resources. So when
cost profiles of several hospitals are available for the manager to review, an
assessment of their relative levels of efficiency may be made.
3. Establishing standards- When cost information is available for a cross-section
of similar type hospitals, the comparison can result in setting a standard for what
that type of hospital should be able to produce with a given set of resources.
4. Cost Projections- Planning for the future What- if scenarios may be generated
with the service volume and costing information generated.

3. TRANSPORTATION INDUSTRY

Price, cost and investment issues in transportation garner intense interest. This is certainly
to be expected from a sector that has been subject to continued public intervention since
the nineteenth century. While arguments of market failure, where the private sector would
not provide the socially optimal amount of transportation service, have previously been
used to justify the economic regulations which characterized the airline, bus, trucking,
and rail industries, it is now generally agreed, and supported by empirical evidence, that
the move to a deregulated system, in which the structure and conduct of the different
modes are a result of the interplay of market forces occurring within and between modes,
will result in greater efficiency and service.

There are many types of costs. Key terms and brief definitions are below

Fixed costs- The costs which do not vary with output.

Variable costs- The costs which change as output levels are changed. The classification
of costs as variable or fixed is a function of both the length of the time horizon and the

extent of indivisibility over the range of output considered.

Total costs- Total expenditures required to achieve a given level of output.
Total costs = fixed costs + variable costs.
Average costs- The total cost divided by the level of output.
Marginal (or incremental ) cost- The derivative (difference) of Total Cost with

respect to a change in output.

Opportunity costs- The actual opportunities forgone as a consequence of doing one
thing as opposed to another. Opportunity cost represents true economics costs, and thus,

must be used in all cases.

Social cost- The cost the society incurs when its resources are used to produce a given

commodity, taking into accounts the external costs and benefits.

Escapable costs (or Avoidable costs)- A cost which can be avoided by curtailing
production. There are both escapable fixed costs and escapable variable costs. The
escapability of costs depends on the time horizon and indivisibility of the costs, and on
the opportunity costs of assets in question.

CHAPTER 4
CASE STUDY
ADHUNIK TRANSPORT ORGANIZATION LIMITED
1. INTRODUCTION
Adhunik Transport Organization Limited was established in the year 1988 as an
organization. In 1991, it got the status of a limited company after reaching the minimum
turnover level. The company currently has a turnover of approximately Rs. 10 Crores. The
company is a member of Bombay Goods Transport Association (BGTA) AND Indian
Bank Association (IBA), which is very essential for the smooth conduct of their business
activities. BGTA checks all business malpractices and IBA is needed for regulating
payments within different states. The company has its 17 branches all over the country,
along with 3 agencies in certain remote areas. The company also provides warehousing
facilities to companies like Philips-India and Colgate. The company is involved in
delivery of goods all over the country.

2. NUMBER OF VEHICLES

The company has owned as well as dedicated trucks and trailers.

Owned Vehicles- 8 HCVs- Heavy Commercial Vehicles 4 Trailers
Dedicated Vehicles-25 LCVs- Light Commercial Vehicles
Dedicated Vehicles are delivery trucks, which are made according to certain
specifications, operated under the name of another company for which they give a
minimum amount of business and certain running costs are borne by that company.
The company has its LCVs dedicated to ELBEE Delivery Services. They are used for
delivering goods given by ELBEE. The driver charges and maintenance charges are borne
by Adhunik Transport. Other expenses are borne by Elbee. The advantage to Elbee is that
its capital is not blocked. The advantage to the company is that it does not have to look for
customers and keeps getting a minimum amount of business.

3. NUMBER OF EMPLOYEES
The Company has on an average 8 office staff members per branch. There are 30 staff
members in the head office in Mumbai. The salaries of these employees vary from Rs.
2,000- Rs. 10,000 depending upon the nature of the job they do.

4. COSTS
Measurement of Materials is done in tons.
FIXED COST
Salaries
Insurance
Transport Permit (every 5 years)
Administrative Overheads

54,00,000
8,00,000
1,00,000
2,11,00,000

Taxes
Depreciation
Interest
TOTAL

30,00,000
34,00,000
3,38,00,000

VARIABLE COST

Maintenance(Per Vehicle)
HCV
LCV
TRAILERS
Wages:
DRIVERS
CLEANERS
Transit Expenses
TOTAL

10,000
6,000
15,000
2,000
1,200
500- 1,500
35,000 approx.

Notes1. There are 2 drivers and 1 cleaner for every long journey.
2. In case of short journeys, there is only 1 driver and 1 cleaner.
3. The maximum distance covered in a day is 300kms. The average distance covered
225-280kms.

CHAPTER 5
5.1 FINDINGS
After studying the topic in depth and data collection from a firm following are the
findings from the project
1. As the subject, important features and advantages of cost accounting are studied and
the project throws light on operating costing
2. It is a method of costing applied by undertakings which provide service rather than
production of commodities. Like unit costing and process costing, operating costing
is thus a form of operation costing.
3. It is applied by transport companies, gas and water works, electricity supply
companies, canteens, hospitals, theatres school etc.
4. The costs, which are incurred to perform the operation of the enterprise, are called
as operating costs. These costs are to be accounted for in order to arrive at the total
costs of operation
5. Operating Costs are the costs incurred by undertakings which do not manufacture
any product but provide a service.
6. The various steps and items of the operating cost sheet is explained in depth along
with illustrative example and cost units for various services
7. The three main area namely Hotel industry
Hospital industry &

 Transport industry
8. Finally , the cost details of Adhunik transport organisation limited are provided
herewith which will help us to know more about operating costing.

5.2 REFERENCES
1. http://www.businessdictionary.com/definition/operating-cost.html#ixzz2uvBn7sy2
2. http://www.wonderwebs.com/Portals/46/Content/Documents/Secured/Bankable
%20Feasibility%20Study/17%20-%20Section%2015%20-%20Operating%20%20Cost.pdf
3. http://costingclub.com/article-details/Operating-Costing-format-for-TransportCompany/132#sthash.WMlndW6e.dpuf
4. Lakmal, D. (n.d.). Retrieved Dec., 8, 2015, from COST ANALYSIS FOR
DECISION MAKING AND CONTROL: file:///C:/Users/S/Downloads/SSRNid2417024.pdf
5. The operating costing on hotel, hospital & transport. (2015, Feb., 8).Retrieved Dec.,
9, 2015, from http://www.slideshare.net/hemantsonawane4/the-operating-costingon-hotelhospital-transportc