MARGINAL COSTING

Marginal costing is one of important technique of cost accounting to control the cost. It is used every type of company who is interested to reduce cost and increase profitability. Marginal costing is also included in all professional accounting courses. That is the reason, you should watch following frequently asked questions (FAQ) of marginal costing. 

Q: - 1. What is marginal costing? 

Ans. Marginal costing means to control the cost by calculating all variable cost and deduct it from sale. With this, we find a special reserve that is called contribution. This contribution can be used to pay fixed cost and rest will be our profit. With this we decide whether we have to produce new product or not, whether we have to diversify of producing of our product or not. Marginal costing is one of best technique, with this, we can proper use of cost-volume- profitability analysis because PV ratio is just relationship of contribution and sales. By calculating it, we can compare two products PV ratio.  Products having high PV ratio will be prefer to produce instead of producing products having  low PV ratio.


Q:- 2. What is marginal Costing formula?

Ans. Following are the main formulae which are used in marginal costing. 

Marginal Cost : Effect on total cost by producing one more or less unit of product. 

Marginal Costing  Equation 

Contribution = Sales - Variable Cost 

or 
Contribution = Fixed Cost +/- Profit

If both side will equal, then 

Contribution = contribution

Sales - Variable cost = Fixed Cost +/- Profit

S - V = F + P 

Profit Volume Ratio =  Contribution / Sale

PV Ratio = Fixed Cost  +/- Profit / Sale or F- P / S

or
PV Ratio = Sales - Variable Cost / Sale or S-V / S 


Q:- 4. What is difference between marginal costing and absorption costing? 

Ans. 1. # Absorption costing is a costing system which treats all costs of production as product costs, regardless weather they are variable or fixed. This would usually include direct materials, direct labor and variable portion of manufacturing overhead. Fixed manufacturing cost is not treated as a product costs under marginal costing.Link

2. # Main difference of marginal costing and absorption costing is of calculating profit. In marginal costing, we calculate profit by calculating contribution and then net profit by deducting fixed cost from contribution. By this, we need not to absorb fixed cost per unit. Per unit cost will be same because we give first preference to marginal cost or variable cost. It is easy to decide by how much contribution (and therefore profit) will be affected by changes in sales volume

3. # In absorption costing, we calculate profit with following formula 

Absorption Cost of Production = Opening stock + Production Cost - closing stock 

Absorption Cost of Sales = Absorption Cost of Production + Add Selling, Admin & Distribution Cost +/- Adjustment of Under or Over absorption of Overheads 

Adjusted Profit = Sales - Absorption Cost of Sales 

But, in marginal costing, we calculate first contribution and then net profit

Contribution = Sales - Variable Cost

Net Profit = Contribution - Fixed Cost 

In marginal costing, however, the actual fixed overhead incurred is wholly charged against contribution.

Q: - 5. What are the main applications of marginal costing?

Ans. Please read it at here. 

Q:- 6. What are the limitations of marginal costing? 

1. Proper classification of fixed and variable cost is not easy. If you deem any fixed cost as variable cost, it may mislead your decision. Moreover, some cost may be semi-variable. We can not classify it either in fixed cost or variable cost.

 

2.  In marginal costing, we give less preference to fixed cost. But fixed cost can also affect net flow of cash and cash from operation. So, your decision may be affected from this point.

 

3. In the area of construction or making of building or big contract, we can not use marginal costing technique for controlling the cost because fixed cost is more important and it should be take as part of cost of production for normal showing of profit every year.

 

Q :-  7. Which product would you recommend to be manufactured in a factory under marginal costing rules, time being the key factor?

 

Given information  :

 

	Per unit of product A	Per unit of product B
	$	$
Direct Material	24	14
Direct Labor at $ 1 per  hour	2	3
Variable Overheads at $ 2  per hour	4	6
Selling Price	100	110
Standard Time to Produce	2hrs.	3 hrs.

Ans. We have to calculate contribution for checking whose contribution is better as per marginal costing rules.

	Per unit of product A	Per unit of product B
	$	$
Selling Price	100	110
Less Marginal Cost  :
Direct Material	( - ) 24	( - )14
Direct Labor at $ 1 per  hour	( - ) 2	( - ) 3
Variable Overheads at $ 2  per hour	( - ) 4	(  - ) 6
Contribution	70	87
Standard Time to Produce	2hrs.	3 hrs.
Contribution Per Hour =  contribution/ standard time	$ 35 per hour	$ 29 per hour

From the above it is clear that contribution per hour of Product A is $ 35 per hour which is more than that of product B by $ 6. There product A is more profitable and is recommend to be manufactured.

Marginal costing is very helpful in managerial decision making. Management's production and cost and sales decisions may be easily affected from marginal costing. That is the reason, it is the part of cost control method of costing accounting. Before explaining the application of marginal costing in managerial decision making, we are providing little introduction to those who are new for understanding this important concept. 

Marginal cost is change in total cost due to increase or decrease one unit or output. It is technique to show the effect on net profit if we classified total cost in variable cost and fixed cost. The ascertainment of marginal costs and of the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs. In marginal costing, marginal cost is always equal to variable cost or cost of goods sold. We must know following formulae

         a)  Contribution ( Per unit) = Sale per unit  - Variable Cost per unit

                   b)  Total profit or loss = Total Contribution - Total Fixed Costs

or                Contribution = Fixed Cost + Profit 

or                 Profit = Contribution - Fixed Cost 

                  c) Profit Volume Ratio = Contribution/ Sale X 100 ( It means if we sell Rs. 100 product, what will be our contribution margin, more contribution margin means more profit)
     
                  d ) Break Even Point is a point where Total sale = Total Cost 

                  e) Break Even Point ( In unit ) = Total Fixed expenses / Contribution 
                 
                 f) Break Even Point ( In Sales Value ) = Break even point (in units)  X Selling price per unit
                  g) Break Even Point at earning of specific net profit margin

= Total Contribution / Contribution per unit 

or  = fixed cost + profit / selling price - variable cost per unit


Application of Marginal Costing in Managerial Decisions 

By effective use of marginal costing formulae, we can apply marginal costing for managerial decisions with following ways :

1st Application : Managerial Decision Relating to Determination of Optimum Selling Price 

To determine the optimum selling price of any product or service is big challenge for a manager of any company because company wants to profit of each unit of any product or service. In marginal costing  technique, fixed cost will not be changed at any level of production. Only variable cost is changed for getting optimum selling price where company can achieve  expected profit.

Example : 
Suppose a company wants to earn 15% net profit margin on 20,000 unit sold. What price will company fix? 
Following other information is give

suppose fixed cost which fixed = Rs. 180,000
suppose variable cost = Rs. 25

This decision can be easily taken with marginal costing's formula. Above, I have written 7 formula. Now we use 7th formula  of out of them. 

Break even units at desired profit = fixed cost + profit / selling price - variable cost per unit
or 

No. of units expected to sell  = Fixed cost + desired profit / contribution per unit 

20000 = 180000 +  15% X ( 20000X S.P) / selling price - 25

20000 X ( S.P. - 25) = 180000+  15% X( 20000 X S.P)

20000 S.P. - 500,000 = 180000 + 3000 S.P

20000 S.P - 3000 S.P = 180000 +500000

17000 S.P = 680000

S.P = 680000/17000 = 40

or 

Expected Selling price = Rs. 40 

2nd Application : To Check the Effect of Reducing of Current Price on  profit

We all know, this is the time of competition, customer has become king. He wants product at minimum price. One example, we can see free video on YouTube. Instead of buying costly CDs and DVD, customers of entertainment industry see free films and movies on YouTube. But on the other side, company wants to maintain his current profit. At that time, manager will be in tension because it is not possible to maintain profit even after reducing price. But if manager learns marginal costing techniques and uses it effective way, they can check the effect of reducing of current price on net profit, after this, he can decide to reduce production or increase production. It is the law of economics, variable cost will reduce by reducing units of production in same proportion but when we increase production, fixed cost will fastly decreases due to constant nature. 

Example : 
Sale of a product amount to 1000 units per annum at Rs. 500 per unit. Fixed overheads are Rs. 100000 per annum and variable cost Rs. 300 per unit. There is a proposal to reduce the price by 20% due to survive in competition. How many units must be sold to maintain total profit after reducing the price by 20%?

First of all we check the effect of reducing of current price on  profit

Our Gross profit ratio or P/V Ratio without reducing price

= Gross profit or Contribution / Sale per unit X 100 = Sale per unit - variable cost per unit / sale per unit X 100

= 500 - 300/500 X 100 = 40%

Break Even Point ( in units where profit is zero ) = Fixed cost / Contribution per unit = 100000/ 200 = 500 units

After reducing 20% of sale price , our gross profit or P/V ratio will be

= 500- 300 / 500 - 500 X 20%  X 100 = 25%

It means our Gross profit will reduce 15% ( 40% -  25%) if we reduce our sale prices 20%.

Break Even Point ( in units where profit is zero ) = Fixed cost / Contribution per unit = 100000/ 100 = 1000 units

Now No. of Units Sold at Break Even point at desired profit :-

For this we have to know present profit 

Present Gross profit or contribution = 40% gross margin on sale X( total no. of sale units X sale per unit) = 

= 40% X ( 1000 units X Rs. 500 per unit ) 

= 2,00,000

Present Net Profit = Contribution or gross profit - Fixed cost = 200,000 - 1,00,000 = 1,00,000

Now, number of units required to maintain same net profit 

= Fixed cost + Net profit / New contribution after reduction of sale prices

= 1,00,000 + 1,00,000 / Rs. 100 = 200,000 / 100 = 2000 units 

Now, manager has to take decision to produce more 1000 units if he wants to earn same gross margin 40% instead of 25%

3rd Application : Choose of Good Product Mix

It may be possible that company is producing more than one product, at that time company has to calculate each product's contribution margin or gross profit margin. After this, manager see which product is giving high contribution margin. Company manager will give preference to that product whose contribution will high. One more decision can be taken by manger. He can check contribution by producing different quantity of different products. If he see any quantity of products is producing maximum contribution, it will be equilibrium point. Production of units at that quantity will be benefited to company. 

4th Application : Calculation of Margin of Safety

 Marginal costing can be utilized for calculating margin of safety. Margin of safety is difference between actual sale and sale at break even point. According to marginal costing rules, production will follow sales. Suppose current sale is Rs. 4,00,000 and BEP is Rs. 3,00,000, margin of safety is Rs.100000. We can calculate it with following formula

= Profit/ P/V ratio

If company's sale is less than margin of safety, then manager can take step to reduce both fixed and variable cost or increase prices. 

5th Application : Decision Regarding to Sell goods at Different Prices to Different Customers 

Sometime, company has to give special discount to special customers. These customers may be govt, foreign companies or wholesaler. At that time manager has to take decision at what limit, we can give discount to special customers. Marginal costing may help in this decision. 

JOB COSTING VS CONTRACT COSTING

Job costing and contract costing both are the methods of costing and used when we receive specific order for performing any work. But after this, there are many differences between job costing and contract costing which we are explaining in four points.

Following are four points which shows as basis of difference between job costing and contract costing:-

1st Point : Area of Work

→ Job costing is used for calculating cost in very small work like making of specific type of product. For instance, if you receive the order of making 10 chairs, you will used job cost in this specific work instead of using contract costing system.

→ Contract costing is used for calculating the cost in very big work like making of 10 floors building or making of bridge.

2nd Point : Period 
→ In job costing, we take that job which can finish within short period.

→ In contract costing, we include that contracts which can finish within one year or more than one year. 

3rd Point : Account
→ In job costing, we make job account for every job. In this account, we show different expenses which are paid for completing that job. 

→ In contract costing, we open contract account for every contract. In this account, we show all expenses relating to contract and it also show work in progress in the form of work certified and work uncertified. Difference of credit and debit side of this account will show notional profit or loss. 

4th Point : Transfer of Profit
→ If specific job is done and finished goods of this job are sold to customers, its all profit will transfer to profit and loss account.

→ In contract costing, we check, how much work is done and on the basis of work certified, we calculate the proportion of notional profit which is transferred to profit and loss account.

CONTRACT COSTING:

Meaning of Contract Costing

Contract costing is that method of costing in cost accounting which is used to collect and identify all the expenses relating to a specific contract. For this purpose, Contractor has to maintain contract ledger in which he has to show contract account.

Contract here means an agreement to complete construction of building or any other engineering work which need many days, months or years to complete.

Contract Account

Contact account is that account who shows all the expenses in its debit side. Credit side of this account, we show value contract price or work certified value. Difference between debit and credit side of will show notional profit or loss.

Following are main Contract Expenses and Costs which shows in Contract Account under Contract Costing :-

1. Material Cost

Material or raw material which is used for construction is the main expense or contract cost and it will be debited in contract account. It is supplied from store or purchased from market directly. If material is transferred from any other contract, then its cost will be adjusted on the basis of material transfer note.

2. Labor Cost

On the basis of wages analysis sheet, labor cost is calculated for a specific contract order. If same labourer is used more than one contract, then time devoted to each contract is calculated and on this basis, labor cost is allocated.

3. Direct Expenses

We also add direct expenses, if any.

4. Overheads

Overheads can be allocated on the basis of some % on cost of material, wages or prime cost or MHR or LHR.

5. Sub- Contract Cost

It will also include in contract cost, if to complete sub-construction for main construction.

6. Cost of Extra Work.

Importance of Contract Costing

Contract costing is important because with this method, we can calculate cost of big jobs. If we do n't know contract costing and calculating of profit under this method, we will usejob costing method and result will not be awesome because many items like value of work certified, notional profit, contract price are not used in job costing. So, it is better for us to learn all things which is in contract costing.

DISCUSS ADVANTAGES AND DISADVANTAGES OF HAVING PIECE RATE SYSTEM?

DISCUSS ADVANTAGES AND DISADVANTAGES OF HAVING PIECE RATE SYSTEM?
The piece rate pay method compensates employees a set amount for each unit of work completed. For example, in a manufacturing setting, an employee receives a set amount for each item he produces, regardless of how fast or slow he works. This payment method is beneficial for both employees and the company, but the potential drawbacks may make it less feasible for your business.

Motivation

The opportunity to earn more money motivates some employees to increase productivity. If the employee increases her work speed, she can complete more units of work in an hour. She could potentially make more per hour than she would with a standard hourly rate. With an hourly pay rate, employees know they cannot make any more no matter how hard they work so they may be less likely to push themselves.

Cost Effective

In many work settings, the piece rate pay method is cost effective, since the company is only paying for work completed. A slower employee may not complete many work units per hour. If you use a standard hourly wage, he gets paid the same, even if he only completes a fraction of the work completed by another employee. You may end up paying him less per hour with the piece rate method if his production is low.

One-Dimensional

The piece rate pay system looks only at productivity making it a one-dimensional system for evaluating work. You may encounter employees who stop worrying as much about quality, instead only worrying about the quantity of work completed for greater earnings. The piece rate method may also discourage teamwork in the workplace because individual employees simply want to complete more of their own work. This method of pay overlooks other elements that go into work that don't produce immediately visible results, including strong decision-making, customer interaction or problem-solving skills.

More Payroll Work

A standard hourly wage is generally easier to calculate each pay period, since it remains the same with the exception of overtime or bonuses. The piece rate pay method requires more work from the payroll department, as the productivity levels fluctuate frequently. Each employee will likely vary at times on the amount produced. You still need a record of the hours worked by the employees. In most cases, each employee's pay must still work out to at least minimum wage, even if production levels are lower

cost and management accounting paper May 2012 ANU CDE BBM

cost and management accounting paper May 2012 ANU CDE BBM
1. WHAT ARE THE ADVANTAGES AND LIMITATIONS OF COST ACCOUNTING :
ANS 1:
Following are the most important advantages of a good cost accounting system:

1) Classification and Subdivision of Costs:
In the contrast to a single profit or loss figure supplied by general accounting, the cost accounting classifies costs and income by every conceivable subdivision of the business enterprise. In a good costing system data regarding costs by departments, processes, functions, products, orders, jobs, contracts and services can easily computed. This detailed cost information for managerial control is one of the most important contributions of cost accounting.

2) Adequacy or Inadequacy of Selling Prices:
Unit cost of production, administration and safe made possible by cost accounting aids management in deciding the adequacy or inadequacy of selling prices i.e. neither too high detracting business, nor too low resulting in losses to the concern.

In period of depressions, slumps, or in case of competition management forced to lower prices even below cost of production and sale. In such circumstances, cost accounting will help management in deciding the proper reduction.

3) Disclosure of profitable Products:
Cost Accounting will disclose activities, departments, products and territories, which bring profit and those that result in losses. Management to determine what products because of profit margin the sales department because of their greater profit margin should emphasize will use this information. What products arte unprofitable or less profitable and might be eliminated or lesser sales pressure be given to them. What activities or territories are not producing sufficient profit and should be either further improved or eliminated and what methods of production and distribution are most profitable for the firm. This will increase the overall profit of the concern.

4) Control of Material and Supplies:
In a good costing system materials and supplies must be accounted for in terms of departments, jobs, units of production or service. This will eliminate altogether or reduce to the minimum misappropriations, embezzlements, deterioration, obsolescence, and losses from defective, spoiled, scrap and out of date materials and supplies.

5) Maintenance of Proper Investment in Inventories:
A costing system will help in the maintenance of various inventory items of materials and supplies in line with production and sale requirements. If these quantities are too small, production may stop or sales may be lost. On the other hand, if quantities of such materials and supplies are in excess of the production and sales requirements, too much working capital may unnecessarily tie up in inventories. The detailed quantity information furnished by the cost accountant at all times will go a long way in reducing or eliminating this possibility.

6) Correct Valuation of Inventories: 
Cost Accounting plays a basic role in the correct valuation of inventories of finished goods, work in process, materials and supplies. The book inventory method (as opposed to physical inventory method) made possible by cost accounting system will involve the operation of the various inventory control accounts in such a manner that the balances of these accounts well be inventory valuations required for periodic financial statements. This enables the preparation of monthly financial statements without the trouble and expense of taking monthly physical inventories.

Further, the value of inventories shown by the book inventory will be more accurate than inventory values shown by the physical inventory method. If no cost system is in use and inventory values computed by physical inventory method, then the value of these inventories must either bean estimate of cost or be determined at market values. But in a cost accounting system accurate procedures and techniques are available by which inventory values can be computed in a relatively more exact fashion. The requirements of management, stockholders, creditors, employees and other groups interested in the financial statements of the firm naturally attach more emphasis on this objective of cost accounting. In most cases, this objective of cost accounting dominates the formal cost records and routines.

7) Whether to Manufacture or Purchase from Outsiders:
Cost records furnish information regarding the cost of manufacturing of different finished parts, which assist management in making a decision whether to purchase these parts from outside manufacturers or manufacture them in the factory.

8) Control of Labour Cost: 
Orders, jobs, contracts, departments, processes, or services record cost of labour. In many manufacturing enterprises, daily time reports are prepared showing the number of hours and minutes spent and the wage rate for each worker per job or operation. This enables management to compare the current cost of labour per job or operation with some previously incurred or determined cost thus measuring the efficiency or inefficiency of the labour force and assigning the work to employees best suited for it.

9) Use of Company-wide Wage Incentive Plans: 
When labour cost is accounted for by jobs and operations, it is possible to use effectively wage incentive plans or bonus schemes for the remuneration of labour force. Carefully planned and administered incentive schemes are an effective means of enforcing superior performance and cost reduction. Workers are more co-operative, responsive and productive when some form of incentive offered to them for surpassing stipulated standards of perfection and performance. Cost of accounting has developed incentive plans, which are applicable not only to factory workers but also to clerks, salespersons, and other executives for above standard performance.

10) Controllable and Uncontrollable Cost: 
Cost accounting exhibits at each stage of production and sale the controllable and uncontrollable items in the manufacturing, selling and administrative cost thus enabling management to concentrate attention on those costs, which can reduced of, eliminated. There is very little the management can do to reduce such uncontrollable items as idle time of machines and labour, wastage in the use of materials, supplies and power can controlled much more effectively.

11) Use of Standards for Measuring Efficiency:
A complete cost accounting system, generally, has a well-developed plan of standards to measure the efficiency of the organization in the use of materials, incurrence of labour and other manufacturing cost. Cora does this appraisal paring the work of factory workers, office and sales personnel and other executive with what should have done in manufacturing and selling a given quantity of units in a given period. 

12) Reduction of Losses Due to Seasonal Conditions: 
Cost accounting provides data for making a complete analysis of losses due to idle plant and equipment or due to the use of plant and equipment beyond normal capacity, irregular employment of labour, wastes in the use of materials. It indicates cost variations between active and inactive periods and seasonal conditions in the business or industry. Seasonal fluctuations in business activity affect profoundly the earnings of the concern. In many industries, seasonal variations are responsible for higher costs and lower profits.

13) Budgeting: 
In a good cost accounting system, preparation of various budgets periods in advance of actual production and sale of goods is necessary. These budgets include budgeted statement of profits, budgeted cost of plant improvements, budgeted cost of production, budgeted cash receipts and payments, and so forth. These budgets show the plans of the management for future periods and they reflect the expected results of these plans. They are of great help in getting the sales manager, the works manager, and the treasurer into agreement as to a plan that can sold, manufactured and financed. In fact, the use of budgets has made costing a preventive device for the rectification of inefficiencies before they creep into the business operations or as they occur from day to day. In other words, budgeting, inculcates the habit of thinking and calculations before taking decisions. 

14) Reliable Check on General Accounting: 
Finally, an efficient and proper system of cost accounting is a most reliable and independent check on the accuracy of the financial accounts. This check made effective through reconciliation of the balance of profit or loss shown by the costing profit and loss account and the balance of profit of profit or loss revealed by the general accounting profit and loss account.

LIMITATIONS OF COST ACCOUNTING :

Advantages of Marginal Costing:

Ø Cost Control: 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 useful to the various levels of management.

Ø Simplicity: Marginal Costing is simple to understand and operate; it can be combined with other forms of costing, such as, budgetary costing, standard costing without much difficulty.

Ø Elimination of varying charge per unit: In marginal Costing fixed overheads are not charged to the cost of production due to this the effect of varying charges per unit is avoided.

Ø Short-Term Profit Planning: It helps in short-term profit planning by break-even charts and profit graphs. Comparative profitability can be easily assessed and brought to the notice of the management for decision-making.

Ø Prevents Illogical Carry forwards: It prevents the illogical carry-forwards in stock-valuation of some proportion of current years fixed overhead.

Ø Accurate Overhead Recovery Rate: It eliminates large balances left in overhead control accounts, which indicate the difficulty of ascertaining an accurate overhead recovery rate.

Ø Maximum return to the business: The effects of alternative sales or production policies can be more readily appreciated and assessed, and decisions taken will yield the maximum return to the business.

Disadvantages of Marginal Costing:

Ø Misleading Results: It is very difficult to segregate all costs into fixed and variable costs very clearly, since all costs are variable in the long run. Hence such segregation sometimes may give misleading results.

Ø Distorted Picture of Profits: The closing stock consists of variable cost only and ignores fixed costs. This gives Distorted Picture of Profits.

Ø Avoids Semi-Variable Costs: Semi-Variable costs are not considered in the analysis.

Ø Problem of Recovery of Overheads: There is problem of under or over-recovery of overheads, since variable costs are apportioned on estimated basis and not on the actuals.

Ø Ignorance of Time Factor: Since the time factor is completely ignored; comparison of performance between two periods on the basis of contribution alone will give the misleading results.

Advantages And Disadvantages Of Absorption Costing System

Advantages Of Absorption Costing System

Following are the main advantages of absorption costing system:

1. Absorption costing recognizes fixed costs in product cost. As it is suitable for determining price of the product. The pricing based on absorption costing ensures that all costs are covered.

2. Absorption costing will show correct profit calculation than variable costing in a situation where production is done to have sales in future ( eg. seasonal production and seasonal sales).

3. Absorption costing conforms with accrual and matching accounting concepts which requires matching costs with revenue for a particular accounting period.

4. Absorption costing has been recognized for the purpose of preparing external reports and for stock valuation purposes.

5. Absorption costing avoids the separating of costs into fixed and variable elements.

6. The allocation and apportionment of fixed factory overheads to cost centers makes manager more aware and responsible for the cost and services provided to others.

Disadvantages Of Absorption Costing System

1. Absorption costing is not useful for decision making. It consider fixed manufacturing overhead as product cost which increase the cost of output. As a result, it does not help in accepting specially offered price for the product. Various types of managerial problems relating to decision making can be solved only with the help of variable costing system.

2. Absorption costing is not helpful in control of cost and planning and control functions. It is not useful in fixing the responsibility for incurrence of costs. It is not practical to hold a manager accountable for costs over which he/she has not control.

3. Some current product costs can be remove from the income statement by producing for inventory. As such, managers who are evaluated on the basis of operating income can temporarily improve profitability by increasing production.

Advantages And Disadvantages Of Activity-Based Costing(ABC)

Advantages Of Activity-Based Costing(ABC):

1. Product cost determination under activity-based costing is more accurate and reliable because it focuses on the cause and effect linkage of costs and activities in the context of producing goods.

2. Fixation of selling price for multi-products under activity-based costing is fair and correct because overheads are allocated on the basis of relevant cost drivers.

3. Control of overheads consisting of fixed and variable becomes possible by controlling and monitoring activities. Linkage between cost and activities are clearly identified in activity-based costing and thus provides opportunities to control overhead costs.

4. Sufficient information can be obtained to make decisions about the profitability of different product lines.

5. Fair allocation of overheads occupy a considerable portion in the total cost components.

Disadvantages Or Limitations Of Activity-Based Costing(ABC)

1. Difficult to identify the overall activities that influence costs.

2. Not easy to select the most suitable cost drive.

3. Difficult to evaluate cost on the basis of activities.

4. Not suitable for small manufacturing concerns.