APPLICATION OF MARGINAL COSTING

CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
One of the most important things in life of a business is decision making. Decision making is an all pervasive activity taking place at every level in the organization, covering both the short and long term. It is concerned with the future and involves a choice between alternatives. The decision making of a business is centered upon the information possessed by the decision maker. However, plans are activated by decisions which require some of financial or qualitative analysis in order to make a rational choice. It is because of this that the practicing management Accountant is heavily engaged in producing relevant information for decision making purpose. The overall objective of a business enterprise is to make profit and as such, the decision on which method of reporting profit to be used at any given time is a very crucial management decision. In traditional costing, there is a very crucial and two basic method of reporting profits. The emphasis in this research will, however, be on the importance of marginal costing techniques in the decision making process. These are:
1. Absorption costing/ full costing
2. Marginal costing period costing/direct costing The practice of charging all costs both variable and fixed to operations, products or processes is termed as absorption costing. The practice of charging all direct costs to operations, processes or products and leaving all indirect costs to be written off against profits in the period in which they arise is termed as direct costing. The technique differs from marginal costing because some fixed costs can be considered as direct costs in appropriate circumstances. According to Browning, 2OOO) Marginal costing is a technique of costing in which allocation of expenditure to production is restricted to those expenses which arise as a result of production, e.g., materials, labor, direct expenses and variable overheads. Fixed overheads are excluded in cases where production varies because it may give misleading results. The technique is useful in manufacturing industries with varying levels of output. The features which distinguish marginal costing from absorption costing are as follows.
1. In absorption costing, items of stock are coasted to include a ‘fair share’ of fixed production overhead, whereas in marginal costing, stocks are valued at variable production cost only. The value of closing stock will be higher in absorption costing than in marginal costing.
2. As a consequence of carrying forward an element of fixed production overheads in closing stock values, the cost of sales used to determine profit in absorption costing will:
1. Include some fixed production overhead costs incurred in a previous period but carried forward into opening stock values of the current period;
2. Exclude some fixed production overhead costs incurred in the current period by including them in closing stock values. In contrast marginal costing charges the actual fixed costs of a period in full into the profit and loss account of the period. (Marginal costing is therefore sometimes known as period costing.)
3. In absorption costing, ‘actual’ fully absorbed unit costs are reduced by producing in greater quantities, whereas in marginal costing, unit variable costs are unaffected by the volume of production (that is, provided that variable costs per unit remain unaltered at the changed level of production activity). Profit per unit in any period can be affected by the actual volume of production in absorption costing; this is not the case in marginal costing. 4. In marginal costing, the identification of variable costs and of contribution enables management to use cost information more easily for decision-making purposes (such as in budget decision making). It is easy to decide by how much contribution (and therefore profit) will be affected by changes in sales volume. (Profit would be unaffected by changes in production volume).
1.2 PURPOSE OF STUDY
The purpose of this research work is to evaluate and critically examine marginal costing technique as an important tool for making managerial decisions. The objectives will include;
1. Showing the importance of marginal costing as a tool for planning and short term decision making.
2. Ascertaining the format to be used on presenting marginal costing information by management Accountants to the management.
3. Evaluating the extent to which marginal costing can be used for pricing method.
4. Examining whether marginal costing has helped the management to achieve high profitability level.
5. Ascertaining the relevant costs to be used in marginal costing computation
1.3 RESEARCH QUESTIONS
1. How effectively preferred is marginal costing techniques to absorption costing techniques in an organization
2. To what extent has marginal costing techniques contributed to decision making in an organization?
3. Does strict adherence to marginal costing technique enhance profitability level and growth of an organization?
4. Does marginal costing techniques serves as a tool for planning and short term decisions?
1.4 STATEMENT OF HYPOTHESIS
The following hypotheses are considered as the basis for the questions set for this study.
Ho: Marginal costing technique is not the best technique for decision making compared to Absorption costing techniques
Hi: Marginal costing technique is the best technique for decision making compared to Absorption costing techniques Ho: Strict adherence to marginal costing technique does not enhance profitability level and growth of an organization compared to strict adherence to Absorption costing technique
Hi: Strict adherence to marginal costing technique enhance profitability level and growth of an organization compared to strict adherence to Absorption costing techniques
Ho: Marginal costing techniques does not serve as a tool for planning and short term decisions compared to absorption costing techniques.
Hi: Marginal costing techniques serves as a tool for planning and short term decisions compared to absorption costing techniques.
1.5 SIGNIFICANCE OF STUDY
The study is expected to be of tremendous help to students and managers in production sector of the economy. At the end of the study, it would be clearly understood and appreciated that marginal costing is a useful technique if used with care and adopted to meet the diverse conditions which apply in a real life environment. The accounting terms and management, after this research work will now see to the fact that a good system of marginal costing techniques is necessary. This will help to reduce the work done by management and make job less complex and cumbersome. This study will advance the use of n costing technique as a good system of marginal costing technique is necessary tool to be used on making decision from the bondage of financial troubles woes. At the end of the study would be appreciated, how and why marginal costing can be an important and necessary aid to decision making. In conclusion, the research study will be useful to Auditors, management of companies, research institutions, professional studies and general public.
1.6 ORGANIZATION OF THE STUDY
This research work will be five (5) chapters for easy comprehension and proper organization. Chapter one will consist of the introduction, statement of problem, research questions, research hypothesis, purpose, scope and limitation of the study, significance of the study, organization, definition of terms of study. Basically, it gives an insight into what the project work is all about. Chapter two reviews relevant literature and the theoretical frame work on the subject matter, and chapter three states the methodology in which the research work is based on. Chapter four states the data analysis and interpretations and highlights the view of respondent on the subject matter. Chapter five state the summary, conclusion and recommendations of the research topic and with references.
1.7 LIMITATION AND SCOPE OF STUDY
This study could have been extended to cover as many companies in order to allow for more representations but due to time and financial constraints this study will be limited to the activities for Nestle Food Plc. The scope of this study will focus on the concept and application of marginal costing technique in Nestle Food Plc from 2001—2005 years of their financial statement.
1.8 DEFINITION OF TERMS
Marginal Costing: This is a decision making technique used to determine the effect of cost on changes in the volume of time and output in a multi product firm especially in the short run. It treats direct costs and variable factory over head as product cot while treating all the fixed overheads as period cost.
Absorption Costing: This is technique which absorbs fixed overhead into period cost through the use of a predetermine overhead absorption rate which is Get annually after budgeted overhead are allocated to cost centres.