What is Absorption Costing?
Absorption Costing technique is also termed as Traditional
or Full Cost Method. According to this method, the cost of
a product is determined after considering both fixed and variable
costs. The variable costs, such as those of direct materials,
direct labor, etc. are directly charged to the products, while
the fixed costs are apportioned on a suitable basis over different
product manufactured during a period. Thus, in case of Absorption
Costing all costs are identified with the manufactured products.
This system of costing has a number of disadvantages:
- It assumes prices are simply a function of costs.
- It does not take account of demand.
- It includes past costs that may not be relevant to the
pricing decision at hand.
- It does not provide information that aids decision making
in a rapidly changing market environment.
Thus, the technique of Absorption Costing may lead to rather
odd results particularly for seasonal businesses in which
the stock level fluctuate widely from one period to another.
The transfer of overheads in and out of stock will influence
their profits for the two periods, showing falling profits
when the sales are high and increasing profits when the sales
are low.
The technique of Absorption Costing may also lead to the
rejection of profitable business. The total unit cost will
tent to be regarded as the lowest possible selling price.
An order at a price, which is less than the total unit cost
may be refused though this order, may actually be profitable.
What is Marginal Costing?
Marginal costing is a special technique used for managerial
decision making. The technique of marginal costing is used
to provide a basis for the interpretation of cost data to
measure the profitability of different products, processes
and cost centers in the course of decision making. It can,
therefore, be used in conjunction with the different methods
of costing such as job costing, process costing etc., or even
with other techniques such as standard costing or budgetary
control. .
In marginal costing, cost ascertainment is
made on the basis of the nature of cost. 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 of costs 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 total of the cost of direct material,
direct labor, direct expenses, manufacturing overheads, administration
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 continuously
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 a thing costs Rs. 20 and next day it costs
Rs. 18. This situation arises because of changes in volume
of output and the peculiar behaviour of fixed expenses comprised
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 given wide recognition in the
field of decision making.
Q. Write short notes on Absorption Costing & Marginal Costing. |
Accounts
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