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There are several costs that a firm should consider under relevant circumstances.

It is quite essential for a firm to understand the difference between various cost concepts for the purpose of production/business decision making. The following are the various cost concepts/types of costs.

(A) Actual Cost (B) Opportunity Cost (C) Sunk Cost (D) Incremental Cost (E) Explicit Cost (F) Implicit Cost (G) Book Cost (H) Out Of Pocket Costs (I) Accounting Costs (J) Economic Costs (K) Direct Cost (L) Indirect Costs (M) Controllable Costs (N) Non Controllable Costs (O) Historical Costs and Replacement Costs. (P) Shutdown Costs (Q) Abandonment Costs (R) Urgent Costs and Postponable Costs (S) Business Cost and Full Cost (T) Fixed Costs (U) Variable Costs (V) Total Cost, Average Cost and Marginal Cost (W) Short Run Cost and Long Run Cost

Cost
Definition Something of value, usually an amount of money, given up in exchange for something else, usually goods or services. All expenses are costs, but not allcosts are expenses. (An expense is the cost of resources used to produce revenue.) As a verb, cost means to estimate the amount of money needed to produce a product or perform a service.

Different Types of Costs with Examples - From M to W?

(A) Actual Cost Actual cost is defined as the cost or expenditure which a firm incurs for producing or acquiring a good or service. The actual costs or expenditures are recorded in the books of accounts of a business unit. Actual costs are also called as "Outlay Costs" or "Absolute Costs" or "Acquisition Costs". Examples: Cost of raw materials, Wage Bill etc. (B) Opportunity Cost Opportunity cost is concerned with the cost of forgone opportunities/alternatives. In other words, it is the return

from the second best use of the firms resources which the firms forgoes in order to avail of the return from the best use of the resources. It can also be said as the comparison between the policy that was chosen and the policy that was rejected. The concept of opportunity cost focuses on the net revenue that could be generated in the next best use of a scare input. Opportunity cost is also called as "Alternative Cost". If a firm owns a land, there is no cost of using the land (ie., the rent) in the firms account. But the firm has an opportunity cost of using the land, which is equal to the rent forgone by not letting the land out on rent. (C) Sunk Cost Sunk costs are those do not alter by varying the nature or level of business activity. Sunk costs are generally not taken into consideration in decision - making as they do not vary with the changes in the future. Sunk costs are a part of the outlay/actual costs. Sunk costs are also called as "Non-Avoidable costs" or "Inescapable costs". Examples: All the past costs are considered as sunk costs. The best example is amortization of past expenses, like depreciation. (D) Incremental Cost Incremental costs are addition to costs resulting from a change in the nature of level of business activity. As the costs can be avoided by not bringing any variation in the activity in the activity, they are also called as "Avoidable Costs" or "Escapable Costs". More ever incremental costs resulting from a contemplated change is the Future, they are also called as "Differential Costs" Example: Change in distribution channels adding or deleting a product in the product line. (E) Explicit Cost Explicit costs are those expenses/expenditures that are actually paid by the firm. These costs are recorded in the books of accounts. Explicit costs are important for calculating the profit and loss accounts and guide in economic decision-making. Explicit costs are also called as "Paid out costs" Example: Interest payment on borrowed funds, rent payment, wages, utility expenses etc. (F) Implicit Cost Implicit costs are a part of opportunity cost. They are the theoretical costs ie., they are not recognised by the accounting system and are not recorded in the books of accounts but are very important in certain decisions. They are also called as the earnings of those employed resources which belong to the owner himself. Implicit costs are also called as "Imputed costs". Examples: Rent on idle land, depreciation on dully depreciated property still in use, interest on equity capital etc. (G) Book Cost Book costs are those business costs which don't involve any cash payments but a provision is made in the books of accounts in order to include them in the profit and loss account and take tax advantages, like provision for depreciation and for unpaid amount of the interest on the owners capital. (H) Out Of Pocket Costs Out of pocket costs are those costs are expenses which are current payments to the outsiders of the firm. All the explicit costs fall into the category of out of pocket costs. Examples: Rent Payed, wages, salaries, interest etc (I) Accounting Costs Accounting costs are the actual or outlay costs that point out the amount of expenditure that has already been incurred on a particular process or on production as such accounting costs facilitate for managing the taxation need and profitability of the firm. Examples: All Sunk costs are accounting costs (J) Economic Costs Economic costs are related to future. They play a vital role in business decisions as the costs considered in decision - making are usually future costs. They have the nature similar to that of incremental, imputed explicit and opportunity costs. (K) Direct Cost Direct costs are those which have direct relationship with a unit of operation like manufacturing a product,

organizing a process or an activity etc. In other words, direct costs are those which are directly and definitely identifiable. The nature of the direct costs are related with a particular product/process, they vary with variations in them. Therefore all direct costs are variable in nature. It is also called as "Traceable Costs" Examples: In operating railway services, the costs of wagons, coaches and engines are direct costs. (L) Indirect Costs Indirect costs are those which cannot be easily and definitely identifiable in relation to a plant, a product, a process or a department. Like the direct costs indirect costs, do not vary ie., they may or may not be variable in nature. However, the nature of indirect costs depend upon the costing under consideration. Indirect costs are both the fixed and the variable type as they may or may not vary as a result of the proposed changes in the production process etc. Indirect costs are also called as Non-traceable costs. Example: The cost of factory building, the track of a railway system etc., are fixed indirect costs and the costs of machinery, labour etc.

(M) Controllable Costs


Controllable costs are those which can be controlled or regulated through observation by an executive and therefore they can be used for assessing the efficiency of the executive. Most of the costs are controllable. Example: Inventory costs can be controlled at the shop level etc. (N) Non Controllable Costs The costs which cannot be subjected to administrative control and supervision are called non controllable costs. Example: Costs due obsolesce and depreciation, capital costs etc. (O) Historical Costs and Replacement Costs. Historical cost or original costs of an asset refers to the original price paid by the management to purchase it in the past. Whereas replacement costs refers to the cost that a firm incurs to replace or acquire the same asset now. The distinction between the historical cost and the replacement cost result from the changes of prices over time. In conventional financial accounts, the value of an asset is shown at their historical costs but in decision-making the firm needs to adjust them to reflect price level changes. Example: If a firm acquires a machine for $20,000 in the year 1990 and the same machine costs $40,000 now. The amount $20,000 is the historical cost and the amount $40,000 is the replacement cost. (P) Shutdown Costs The costs which a firm incurs when it temporarily stops its operations are called shutdown costs. These costs can be saved when the firm again start its operations. Shutdown costs include fixed costs, maintenance cost, layoff expenses etc. (Q) Abandonment Costs Abandonment costs are those costs which are incurred for the complete removal of the fixed asset from use. These may occur due to obsolesce or due to improvisation of the firm. Abandonment costs thus involve problem of disposal of the asset. (R) Urget Costs and Postponable Costs Urgent costs are those costs which have to be incurred compulsorily by the management in order to continue its operations. If urgent costs are not incurred in time the operational efficiency of the firm falls.

Example: Cost of material, labour, fuel etc Postponable costs are those which if not incurred in time do not effect the operational efficiency of the firm. Examples are maintenance costs. (S) Business Cost and Full Cost Business costs include all the expenses incurred by the firm to carry out business activities. Costs Include all the payments and contractual obligations made by the firm together with the book cost of depreciation on plant and equipment. Full costs include business costs, opportunity costs, and normal profits. Opportunity costs is the expected return/earnings from the next best use of the firms resources like capital, land and building, owners efforts and time. Normal profits is necessary minimum earning in addition to the opportunity costs, which a firm must receive to remain in its present occupation. (T) Fixed Costs Fixed costs are the costs that do not vary with the changes in output. In other words, fixed costs are those which are fixed in volume though there are variations in the output level.. If the time period in volume under consideration is long enough to make the adjustments in the capacity of the firm, the fixed costs also vary. Examples: Expenditures on depreciation costs of administrative, staff, rent, land and buildings, taxes etc. (U) Variable Costs Variable Costs are those that are directly dependent on the output ie., they vary with the variation in the volume/level of output. Variable costs increase in output level but not necessarily in the same proportion. The proportionality between the variable costs and output depends upon the utilization of fixed facilities and resources during the production process. Example: Cost of raw materials, expenditure on labour, running cost or maintenance costs of fixed assets such as fuel, repairs, routine maintenance expenditure. (V) Total Cost, Average Cost and Marginal Cost Total cost (TC) refers to the money value of the total resources/inputs required for the production of goods and services by the firm. In other words, it refers to the total outlays of money expenditure, both explicit and implicit, on the resources used to produce a given level output. Total cost includes both fixed and variable costs and is given by TC = VC + FC Average Cost (AC) , refers to the cost per unit of output assuming that production of each unit incurs the same cost. It is statistical in nature and is not an actual cost. It is obtained by dividing Total Cost(TC) by Total Output(Q) AC= TC/Q Marginal costs(MC), refers to the additional costs that are incurred when there is an addition to the existing output level of goods ans services. In other words, it is the addition to the Total Cost(TC) on account of producing additional units. (W) Short Run Cost and Long Run Cost

Both short run and long run costs are related to fixed and variable costs and are often used in economic analysis. Short Run Cost: These costs are which vary with the variation in the output with size of the firm as same. Short run costs are same as variable costs. Broadly, short run costs are associated with variable inputs in the utilization of fixed plant or other requirements. Long Run Cost: These costs are which incurred on the fixed assets like land and building, plant and machinery etc., Long run costs are same as fixed costs. Usually, long run costs are associated with variations in size and kind of plant.

Chapter 2 Marginal Costing and Absorption Costing

Learning Objectives

To understand the meanings of marginal cost and marginal costing To distinguish between marginal costing and absorption costing To ascertain income under both marginal costing and absorption costing

Introduction
The costs that vary with a decision should only be included in decision analysis. For many decisions that involve relatively small variations from existing practice and/or are for relatively limited periods of time, fixed costs are not relevant to the decision. This is because either fixed costs tend to be impossible to alter in the short term or managers are reluctant to alter them in the short term.

Marginal costing - definition


Marginal costing distinguishes between fixed costs and variable costs as convention ally classified. The marginal cost of a product is its variable cost. This is normally taken to be; direct labour, direct material, direct expenses and the variable part of overheads. Marginal costing is formally defined as: the accounting system in which variable costs are charged to cost units and the fixed costs of the period are written-off in full against the aggregate contribution. Its special value is in decision making. (Terminology.)

The term contribution mentioned in the formal definition is the term given to the difference between Sales and Marginal cost. Thus
MARGINAL COST = VARIABLE COST DIRECT LABOUR + DIRECT MATERIAL + DIRECT EXPENSE + VARIABLE OVERHEADS

CONTRIBUTION SALES - MARGINAL COST The term marginal cost sometimes refers to the marginal cost per unit and sometimes to the total marginal costs of a department or batch or operation. The meaning is usually clear from the context. Note Alternative names for marginal costing are the contribution approach and direct costing In this lesson, we will study marginal costing as a technique quite distinct from absorption costing.

Theory of Marginal Costing


The theory of marginal costing as set out in A report on Marginal Costing published by CIMA, London is as follows: In relation to a given volume of output, additional output can normally be obtained at less than proportionate cost because within limits, the aggregate of certain items of cost will tend to remain fixed and only the aggregate of the remainder will tend to rise proportionately with an increase in output. Conversely, a decrease in the volume of output will normally be accompanied by less than proportionate fall in the aggregate cost. The theory of marginal costing may, therefore, by understood in the following two steps: 1. If the volume of output increases, the cost per unit in normal circumstances reduces. Conversely, if an output reduces, the cost per unit increases. If a factory produces 1000 units at a total cost of $3,000 and if by increasing the output by one unit the cost goes up to $3,002, the marginal cost of additional output will be $.2. 2. If an increase in output is more than one, the total increase in cost divided by the total increase in output will give the average marginal cost per unit. If, for example, the output is increased to 1020 units from 1000 units and the total cost to produce these units is $1,045, the average marginal cost per unit is $2.25. It can be described as follows:

Additional cost = $ 45 = $2.25 Additional units 20

The ascertainment of marginal cost is based on the classification and segregation of cost into fixed and variable cost. In order to understand the marginal costing technique, it is essential to understand the meaning of marginal cost. Marginal cost means the cost of the marginal or last unit produced. It is also defined as the cost of one more or one less unit produced besides existing level of production. In this connection, a unit may mean a single commodity, a dozen, a gross or any other measure of goods. For example, if a manufacturing firm produces X unit at a cost of $ 300 and X+1 units at a cost of $ 320, the cost of an additional unit will be $ 20 which is marginal cost. Similarly if the production of X-1 units comes down to $ 280, the cost of marginal unit will be $ 20 (300280). The marginal cost varies directly with the volume of production and marginal cost per unit remains the same. It consists of prime cost, i.e. cost of direct materials, direct labor and all variable overheads. It does not contain any element of fixed cost which is kept separate under marginal cost technique. Marginal costing may be defined as the technique of presenting cost data wherein variable costs and fixed costs are shown separately for managerial decisionmaking. It should be clearly understood that marginal costing is not a method of costing like process costing or job costing. Rather it is simply a method or technique of the analysis of cost information for the guidance of management which tries to find out an effect on profit due to changes in the volume of output. There are different phrases being used for this technique of costing. In UK, marginal costing is a popular phrase whereas in US, it is known as direct costing and is used in place of marginal costing. Variable costing is another name of marginal costing. Marginal costing technique has given birth to a very useful concept of contribution where contribution is given by: Sales revenue less variable cost (marginal cost) Contribution may be defined as the profit before the recovery of fixed costs. Thus, contribution goes toward the recovery of fixed cost and profit, and is equal to fixed cost plus profit (C = F + P). In case a firm neither makes profit nor suffers loss, contribution will be just equal to fixed cost (C = F). this is known as break even point.

The concept of contribution is very useful in marginal costing. It has a fixed relation with sales. The proportion of contribution to sales is known as P/V ratio which remains the same under given conditions of production and sales.

The principles of marginal costing


The principles of marginal costing are as follows. a. For any given period of time, fixed costs will be the same, for any volume of sales and production (provided that the level of activity is within the relevant range). Therefore, by selling an extra item of product or service the following will happen. Revenue will increase by the sales value of the item sold. Costs will increase by the variable cost per unit. Profit will increase by the amount of contribution earned from the extra item. b. Similarly, if the volume of sales falls by one item, the profit will fall by the amount of contribution earned from the item. c. Profit measurement should therefore be based on an analysis of total contribution. Since fixed costs relate to a period of time, and do not change with increases or decreases in sales volume, it is misleading to charge units of sale with a share of fixed costs. d. When a unit of product is made, the extra costs incurred in its manufacture are the variable production costs. Fixed costs are unaffected, and no extra fixed costs are incurred when output is increased.

Features of Marginal Costing


The main features of marginal costing are as follows: 1. Cost Classification The marginal costing technique makes a sharp distinction between variable costs and fixed costs. It is the variable cost on the basis of which production and sales policies are designed by a firm following the marginal costing technique. 2. Stock/Inventory Valuation Under marginal costing, inventory/stock for profit measurement is valued at marginal cost. It is in sharp contrast to the total unit cost under absorption costing method. 3. Marginal Contribution Marginal costing technique makes use of marginal contribution for marking various decisions. Marginal contribution is the difference between sales and marginal cost. It forms the basis for judging the profitability of different products or departments.

Advantages and Disadvantages of Marginal Costing Technique Advantages


1. Marginal costing is simple to understand. 2. By not charging fixed overhead to cost of production, the effect of varying charges per unit is avoided. 3. It prevents the illogical carry forward in stock valuation of some proportion of current years fixed overhead. 4. 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. 5. It eliminates large balances left in overhead control accounts which indicate the difficulty of ascertaining an accurate overhead recovery rate. 6. 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. 7. 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.

Disadvantages
1. The separation of costs into fixed and variable is difficult and sometimes gives misleading results. 2. Normal costing systems also apply overhead under normal operating volume and this shows that no advantage is gained by marginal costing. 3. 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. 4. Volume variance in standard costing also discloses the effect of fluctuating output on fixed overhead. Marginal cost data becomes unrealistic in case of highly fluctuating levels of production, e.g., in case of seasonal factories. 5. Application of fixed overhead depends on estimates and not on the actuals and as such there may be under or over absorption of the same. 6. 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. 7. 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. Presentation of Cost Data under Marginal Costing and Absorption Costing Marginal costing is not a method of costing but a technique of presentation of sales and cost data with a view to guide management in decision-making. The traditional technique popularly known as total cost or absorption costing technique does not make any difference between variable and fixed cost in the calculation of profits. But marginal cost statement very clearly indicates this difference in arriving at the net operational results of a firm. Following presentation of two Performa shows the difference between the presentation of information according to absorption and marginal costing techniques:

MARGINAL COSTING PRO-FORMA



Sales Revenue xxxxx Less Marginal Cost of Sales Opening Stock (Valued @ marginal cost) xxxx Add Production Cost (Valued @ marginal cost) xxxx Total Production Cost xxxx Less Closing Stock (Valued @ marginal cost) (xxx) Marginal Cost of Production xxxx Add Selling, Admin & Distribution Cost xxxx Marginal Cost of Sales (xxxx) Contribution xxxxx Less Fixed Cost (xxxx) Marginal Costing Profit xxxxx

ABSORPTION COSTING PRO-FORMA



Sales Revenue xxxxx Less Absorption Cost of Sales Opening Stock (Valued @ absorption cost) xxxx Add Production Cost (Valued @ absorption cost) xxxx Total Production Cost xxxx Less Closing Stock (Valued @ absorption cost) (xxx) Absorption Cost of Production xxxx Add Selling, Admin & Distribution Cost xxxx Absorption Cost of Sales (xxxx)

Un-Adjusted Profit Fixed Production O/H absorbed Fixed Production O/H incurred (Under)/Over Absorption Adjusted Profit

xxxxx xxxx (xxxx) xxxxx xxxxx

Reconciliation Statement for Marginal Costing and Absorption Costing Profit


$ Marginal Costing Profit xx ADD xx (Closing stock opening Stock) x OAR = Absorption Costing Profit xx Budgeted fixed production overhead Where OAR( overhead absorption rate) = Budgeted levels of activities

Marginal Costing versus Absorption Costing


After knowing the two techniques of marginal costing and absorption costing, we have seen that the net profits are not the same because of the following reasons:

1. Over and Under Absorbed Overheads


In absorption costing, fixed overheads can never be absorbed exactly because of difficulty in forecasting costs and volume of output. If these balances of under or over absorbed/recovery are not written off to costing profit and loss account, the actual amount incurred is not shown in it. In marginal costing, however, the actual fixed overhead incurred is wholly charged against contribution and hence, there will be some difference in net profits.

2. Difference in Stock Valuation


In marginal costing, work in progress and finished stocks are valued at marginal cost, but in absorption costing, they are valued at total production cost. Hence, profit will differ as different amounts of fixed overheads are considered in two accounts. The profit difference due to difference in stock valuation is summarized as follows: a. When there is no opening and closing stocks, there will be no difference in profit.

b. When opening and closing stocks are same, there will be no difference in profit, provided the fixed cost element in opening and closing stocks are of the same amount. c. When closing stock is more than opening stock, the profit under absorption costing will be higher as comparatively a greater portion of fixed cost is included in closing stock and carried over to next period. d. When closing stock is less than opening stock, the profit under absorption costing will be less as comparatively a higher amount of fixed cost contained in opening stock is debited during the current period.

The features which distinguish marginal costing from absorption costing are as follows.
a. In absorption costing, items of stock are costed 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. b. 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: i. include some fixed production overhead costs incurred in a previous period but carried forward into opening stock values of the current period; ii. 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.) c. 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. d. In marginal costing, the identification of variable costs and of contribution enables management to use cost information more easily for decisionmaking 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).

In absorption costing, however, the effect on profit in a period of changes in both: i. ii. production volume; and sales volume; is not easily seen, because behaviour is not analysed and incremental costs are not used in the calculation of actual profit.

Limitations of Absorption Costing


The following are the criticisms against absorption costing: 1. You might have observed that in absorption costing, a portion of fixed cost is carried over to the subsequent accounting period as part of closing stock. This is an unsound practice because costs pertaining to a period should not be allowed to be vitiated by the inclusion of costs pertaining to the previous period and vice versa. 2. Further, absorption costing is dependent on the levels of output which may vary from period to period, and consequently cost per unit changes due to the existence of fixed overhead. Unless fixed overhead rate is based on normal capacity, such changed costs are not helpful for the purposes of comparison and control. The cost to produce an extra unit is variable production cost. It is realistic to the value of closing stock items as this is a directly attributable cost. The size of total contribution varies directly with sales volume at a constant rate per unit. For the decision-making purpose of management, better information about expected profit is obtained from the use of variable costs and contribution approach in the accounting system.

Summary
Marginal cost is the cost management technique for the analysis of cost and revenue information and for the guidance of management. The presentation of information through marginal costing statement is easily understood by all mangers, even those who do not have preliminary knowledge and implications of the subjects of cost and management accounting. Absorption costing and marginal costing are two different techniques of cost accounting. Absorption costing is widely used for cost control purpose whereas marginal costing is used for managerial decision-making and control.

The difference between Marginal Costing and Absorption Costing can be narrated as below:
Absorption Costing Calculation of In this absorption rate include Marginal Costing Marginal costing rates includes

Manufacture
Overhead rates Valuation of Inventory

fixed and variable manufacturing only variable manufacturing


Overheads. Overhead. Marginal costing it will be at prime

In Absorption Costing valuation is on Product cost ie. applied fixed and variable manufacturing overheads.

Prime cost + cost + applied variable manufactur ing overhead.

Classification of overheads are


Overhead

In Absorption costing the over

In Marginal costing

head may be classified as factory, administrative, selling and distribution.

are classified as variable and fixed.

Operating Profit

Under Absorptions Costing Gross Profit-NetSales Manufacturing cost = Prime cost +Fixed and Variable manufacturing

In Marginal costing, Marginal income or contribution = net sales - variable manufacturing cost of goods soldvariable administrative selling and distribution overhead.

Overhead. Net operating


Profit

Under Absorption costing,


Profit = administrative selling And distribution overheads (

Under Marginal costing Net

Net operating profit = Gross

operating profit = Marginal income or contribution fixed manufacturing overheads fixed administrative

Fixed and variable combined). Difference of When production volume


Profit exceeds sales volume the net

Overheads fixed selling and


distribution overhead

When production volume is less ing net profit will be less than

than sales volume, absorption cost

Profit under absorption costing marginal net profit


Net Profit. The Net profit will be

equal when production volume is equal to sales volume.

Absorption Costing vs Marginal Costing The system of computing the cost of production is known as costing. The main purpose of any costing system is to identify the cost incurred for the production of a unit output. In a manufacturing company, identifying the cost associated with a unit product is very important to price the product such that the company could make a profit and survive to exist in the future. Both absorption costing and marginal costing are traditional system of costing. Both methods have their own pros and cons. In modern management accounting, there are some sophisticated costing methods such as activity based costing (ABC) that are very popular. Those methods are built up just by adding and amending some principles of the principles of traditional costing system. Marginal Costing Marginal costing calculates the cost to be incurred when an additional unit is produced. Prime cost, which includes direct material, direct labour, direct expenses, and variable overheads are the main components of marginal costing. Contribution is a concept developed along with marginal costing. Contribution is the net sales revenue to the variable cost. Under marginal costing methods, fixed costs are not taken into account based on the argument that fixed cost like factory rent, utilities, amortization, etc. are to be incurred, whether the production is done or not. In marginal costing, fixed cost are treated as period cost. Often managers require marginal costing to make decisions as it contains costs that vary with the number of unit produced. Marginal costing is also known as variable costing and direct costing. Absorption Costing Under Absorption costing method, not only the variable costs, but fixed costs also absorbed by the product. Most accounting principles require absorption costing for the purpose of external reporting. This method is always used to prepare financial statements. Adsorption costing is used to calculate profit and stock valuation in the financial statement. As stock cannot be undervalued in this method, Inland Revenue requires this costing. Fixed costs are taken into account on the assumption that they must be recovered. The terms Full absorption costing and Full costing also denote the absorption costing. What is the difference between Marginal Costing and Absorption Costing? Though, marginal costing and absorption costing are two traditional costing techniques, they have their own unique principles that draw a fine line that separates one from another. In marginal costing, contribution is calculated, whereas this is not calculated under absorption costing. When valuing the stocks under marginal costing, only the variable costs are considered, whereas valuation of stock under absorption costing includes costs incurred for the production function also. Generally, the value of inventory is higher under absorption costing than marginal costing. Marginal costing is often used for internal reporting purposes (facilitate the decision making of managers), while absorption costing is required for external reporting purposes, such as income tax reporting. Contribution must be calculated under marginal costing system, whereas gross profit will be calculated under absorption costing method.

ABSORPTION VS VARIABLE COSTING LECTURE BREAKEVEN ANALYSIS

Absorption Costing vs Variable Costing

Remember: An asset is a resource of the company that gives a future economic benefit. Inventories are assets because they give future benefits to the company in the terms of sales revenue.

Absorption costing: includes all manufacturing costs --- including direct materials, direct labor, and BOTH variable and fixed manufacturing overhead.

Absorption Costing = Full Costing

Under absorption costing, fixed overhead is a product cost until sold.

Absorption costing makes no distinction between fixed and variable costs thus is not suited for CVP analysis.

Sales less Absorption Cost of Goods Sold will equal Gross Profit

Functional Analysis of the Income Statement

Variable costing: includes only variable manufacturing costs --- direct materials, direct labor, and variable manufacturing overhead.

The entire amount of fixed costs are expenses in the year incurred.

When calculating Contribution Margin, Variable Cost of Goods Sold and Variable Selling and Administrative Expenses and subtracted from Sales.

Behavioral Analysis of the Income Statement

Variable costing can be used for Cost Volume Profit (Break-even Analysis) Rules about Absorption Costing versus Variable Costing.

Rules about unit sales and production under the two costing methods.

If sales are variable and production constant.

a. When production is equal to sales, then absorption costing and variable costing will give the same amount of net income.

b. When production is greater than sales, then Net Income under absorption costing will be greater than net income under variable costing because a portion of the fixed costs was deferred to other years under the absorption method.

c. When production is less than sales, then Net Income under absorption costing will be less than net income under variable costing because a portion of the fixed costs that were deferred from previous years will be absorbed into this years cost of goods sold.

d. The value of inventory will be greater under the absorption method because of the deferred costs, however the total unit count will be the same for each accounting method.

e. Over the long-term, net income will be equal under both methods.

If sales are constant and production is variable then:

a. Net income under variable costing is not influenced by the fluctuations in sales (given a constant production) because none of the fixed manufacturing costs are deferred.

b. Net income under absorption costing is influenced by the fluctuations in sales (given a constant production) because a portion of the fixed manufacturing costs are deferred and may be used each year to increase costs.

Should Fixed Manufacturing Costs be Included in Inventories?

Advocates of full costing say yes, because all of the production costs are needed to create the products. Thus, they have "future economic benefits."

Advocates of variable costing argue that in order for a fixed manufacturing cost to be an asset, it has to meet a "future cost avoidance" criteria much the same way as prepaid insurance. In the case of fixed manufacturing costs, they do not meet this criteria because they are incurred each time the production line opens. Thus, they need to be expenses in that period and only variance expenses inventoried.

Problems with absorption costing also include potential manipulations by plant managers such as increasing production regardless of sales levels to defer costs to the next year and show a higher current profit for the sake of bonuses and promotions

Example of Absorption versus Variable Costing Data

Units Produced Sales Price Direct Materials Cost per Unit Direct Labor Cost Per Unit Variable Manufacturing Cost Per unit Variable Sales Cost per Unit Fixed Manufacturing Overhead Fixed Selling Costs

200,000 $15.00 $4.00 $3.00 $2.00 $1.00 $200,000 $100,000

Unit Cost Under Absorption Costing: Data


Direct Materials Cost per Unit Direct Labor Cost Per Unit Variable Manufacturing Cost Per unit Fixed Manufacturing Overhead Per unit

Unit Cost Under Variable Costing:

Direct Materials Cost per Unit Direct Labor Cost Per Unit Variable Manufacturing Cost Per unit Total Cost Per Unit

Income statement under Absorption if only 180,000 units were sold:


Sales Cost of Goods Sold Beginning Inventory Cost of Goods Manufactured Goods Available for Sale Ending Inventory Cost of Goods Sold Gross Profit Variable Selling Fixed Selling Net Income

Income statement under Variable Costing if 180,000 units were sold:

Sales Cost of Goods Sold Beginning Inventory Cost of Goods Manufactured Goods Available for Sale Ending Inventory Variable Cost of Goods Sold Variable Selling Total Variable Costs Contribution Margin Fixed Manufacturing Overhead Fixed Selling Net Income

Reconciliation:

Example of Absorption versus Variable Costing -- Answer Data


Units Produced Sales Price Direct Materials Cost per Unit Direct Labor Cost Per Unit Variable Manufacturing Cost Per unit Variable Sales Cost per Unit Fixed Manufacturing Overhead Fixed Selling Costs 200,000 $15.00 $4.00 $3.00 $2.00 $1.00 $200,000 $100,000

Unit Cost Under Absorption Costing: Data


Direct Materials Cost per Unit Direct Labor Cost Per Unit Variable Manufacturing Cost Per unit Fixed Manufacturing Overhead Per unit $4.00 $3.00 $2.00 $200,000/ 200,000 units $1.00 $10.00

Unit Cost Under Variable Costing:

Direct Materials Cost per Unit Direct Labor Cost Per Unit Variable Manufacturing Cost Per unit Total Cost Per Unit

$4.00 $3.00 $2.00 $9.00

Target Profit ---- $150,000 Tax Rate --- 40%

Income statement under Absorption if only 180,000 units were sold:


Sales 15 x 180,000 units Cost of Goods Sold Beginning Inventory Cost of Goods Manufactured Goods Available for Sale Ending Inventory Cost of Goods Sold Gross Profit Variable Selling Fixed Selling Net Income $2,700,000 0 $2,000,000 2,000,000 200,000 1,800,000 900,000 180,000 100,000 $620,000

$10 x 200,000 $10 x 20,000

$1 x 180,000

Income statement under Variable Costing if 180,000 units were sold:

Sales 15 x 180,000 units Cost of Goods Sold Beginning Inventory Cost of Goods Manufactured Goods Available for Sale Ending Inventory Variable Cost of Goods Sold Variable Selling Total Variable Costs Contribution Margin Fixed Manufacturing Overhead Fixed Selling Net Income

$2,700,000 0 $1,800,000 1,800,000 180,000 1,620,000 180,000 1,800,000 900,000 200,000 100,000 $600,000

$9 x 200,000 $9 x 20,000 $1 x 180,000

Reconciliation: $620,000 - $600,000 = $20,000/20,000 units = The $1.00 per unit difference in inventory costs. Essentially $20,000 [20,000 units x $1.00] in costs were deferred to the next accounting period under Absorption costing.

ANS 4:

Angle of incidence
From Wikipedia, the free encyclopedia

This article needs additional citations for verification. Please help improve this article by adding citations to reliable sources. Unsourced material may be challenged and removed.(September 2009)

Angle of incidence

Angle of incidence is a measure of deviation of something from "straight on", for example:

in the approach of a ray to a surface, or the angle at which the wing or horizontal tail of an airplane is installed on the fuselage, measured relative to the axis of the fuselage.

Contents
[hide]

1 Optics

1.1 Grazing angle

2 Angle of incidence of fixed-wing aircraft 3 See also 4 Notes 5 External links

[edit]Optics
In geometric optics, the angle of incidence is the angle between a ray incident on a surface and the line perpendicular to the surface at the point of incidence, called the normal. The ray can be formed by any wave: optical, acoustic, microwave, X-ray and so on. In the figure above, the red line representing a ray makes an angle with the normal (dotted line). The angle of incidence at which light is first totally internally reflected is known as the critical angle. The angle of reflection and angle of refraction are other angles related to beams.

[edit]Grazing

angle

When dealing with a beam that is nearly parallel to a surface, it is sometimes more useful to refer to the angle between the beam and the surface, rather than that between the beam and the surface normal, in other words 90 minus the angle of incidence. This angle is called aglancing angle or grazing angle. Incidence at small grazing angle is called "grazing incidence". Grazing incidence diffraction is used in X-ray spectroscopy and atom optics, where significant reflection can be achieved only at small values of the grazing angle. Ridged mirrors are designed for reflection of atoms coming at small grazing angle. This angle is usually measured inmilliradians. Determining the grazing angle with respect to a planar surface is trivial, but the computation for almost any other surface is significantly more difficult. The exact solution for a sphere (which has important applications in astronomy and computer graphics) was an open problem for nearly 50 years until a closedform result was derived by mathematicians Allen R Miller and Emanuel Vegh in 1991.[1]

[edit]Angle

of incidence of fixed-wing aircraft

Angle of incidence of an airplane wing on an airplane.

On fixed-wing aircraft, angle of incidence is the angle between the chord line of the wing where the wing is mounted to the fuselage and thelongitudinal axis of the fuselage. The angle of incidence is fixed in the design of the aircraft by the mounting of the wing to the fuselage. The term can also be applied to horizontal surfaces in general (such as canards or horizontal stabilizers) for the angle they make relative the longitudinal axis of the fuselage. The figure to the right shows a side view of an airplane. The extended chord line of the wing root (red line) makes an angle with the longitudinal axis (roll axis) of the aircraft (blue line). Wings are typically mounted at a small positive angle of incidence, to allow the fuselage to be "flat" to the airflow in normal cruising flight. Angles of incidence of about 6 are common on most general aviation designs. Other terms for angle of incidence in this context are rigging angle andrigger's angle of incidence. It should not be confused with the angle of attack, which is the angle the wing chord presents to the airflow in flight. Note that some ambiguity in this terminology exists, as some engineering texts that focus solely on the study of airfoils and their medium may use either term when referring to angle of attack. The use of the term "angle of incidence" to refer to the angle of attack occurs chiefly in British usage. [2]

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angle of incidence
n. The angle formed by a ray incident on a surface and a perpendicular to the surface at the point of incidence.

The American Heritage Dictionary of the English Language, Fourth Edition copyright 2000 by Houghton Mifflin Company. Updated in 2009. Published by Houghton Mifflin Company. All rights reserved.

angle of incidence
n

1. (Physics / General Physics) the angle that a line or beam of radiation makes with the normal to the surface at the point of incidence

2. (Engineering / Aeronautics) another name for angle of attack

3. (Engineering / Aeronautics) Also called rigging angle of incidence the angle between the chord line of an aircraft wing or tailplane and the aircraft's longitudinal axis
Collins English Dictionary Complete and Unabridged HarperCollins Publishers 1991, 1994, 1998, 2000, 2003

angle of incidence
The angle formed by a ray or wave, as of light or sound, striking a surface and a line perpendicular to the surface at the point of impact.
The American Heritage Science Dictionary Copyright 2005 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved.

ThesaurusLegend:

Synonyms Related Words Antonyms Noun 1. angle of incidence - the angle that a line makes with a line perpendicular to the surface at the point of incidence

ANS 6

What is Responsibility Accounting?


Summary by James R. Martin Most of this material is from MAAW's Chapter 9 Responsibility Accounting Main Page | Responsibility Accounting Summary Responsibility accounting is an underlying concept of accounting performance measurement systems. The basic idea is that large diversified organizations are difficult, if not impossible to manage as a single segment, thus they must be decentralized or separated into manageable parts. These parts, or segments are referred to as responsibility centers that include: 1) revenue centers, 2) cost centers, 3) profit centers and 4) investment centers. This approach allows responsibility to be assigned to the segment managers that have the greatest amount of influence over the key elements to be managed. These elements include revenue for a

revenue center (a segment that mainly generates revenue with relatively little costs), costs for a cost center (a segment that generates costs, but no revenue), a measure of profitability for a profit center (a segment that generates both revenue and costs) and return on investment (ROI) for an investment center (a segment such as a division of a company where the manager controls the acquisition and utilization of assets, as well as revenue and costs). Controllability Concept An underlying concept of responsibility accounting is referred to as controllability. Conceptually, a manager should only be held responsible for those aspects of performance that he or she can control. In my view, this concept is rarely, if ever, applied successfully in practice because of the system variation present in all systems. Attempts to apply the controllability concept produce responsibility reports where each layer of management is held responsible for all subordinate management layers as illustrated below.

Advantages and Disadvantages

Responsibility accounting has been an accepted part of traditional accounting control systems for many years because it provides an organization with a number of advantages. Perhaps the most compelling argument for the responsibility accounting approach is that it provides a way to manage an organization that would otherwise be unmanageable. In addition, assigning responsibility to lower level managers allows higher level managers to pursue other activities such as long term planning and policy making. It also provides a way to motivate lower level managers and workers. Managers and workers in an individualistic system tend to be motivated by measurements that emphasize their individual performances. However, this emphasis on the performance of individuals and individual segments creates what some critics refer to as the "stovepipe organization." Others have used the term "functional silos" to describe the same idea. Consider 9-6 Exhibit below1. Information flows vertically, rather than horizontally. Individuals in the various segments and functional areas are separated and tend to ignore the interdependencies within the organization. Segment managers and individual workers within segments tend to compete to optimize their own performance measurements rather than working together to optimize the performance of the system.

Summary and Controversial Question An implicit assumption of responsibility accounting is that separating a company into responsibility centers that are controlled in a top down manner is the way to optimize the system. However, this separation inevitably fails to consider many of the interdependencies within the organization. Ignoring the interdependencies prevents teamwork and creates the need for buffers such as additional inventory, workers, managers and capacity. Of course, a system that prevents teamwork and creates excess is inconsistent with the lean enterprise concepts of just-in-time and the theory of constraints. For this reason, critics of traditional accounting control systems advocate managing the system as a whole to eliminate the need for buffers and excess. They also argue that companies need to develop process oriented learning support systems, not financial results, fear oriented control systems. The information system needs to reveal the company's problems and constraints in a timely manner and at a disaggregated level so that empowered users can identify how to correct problems, remove constraints and improve the process. According to these critics, accounting control information does not qualify in any of these categories because it is not timely, disaggregated, or user friendly. This harsh criticism of accounting control information leads us to a very important controversial question. Can a company successfully implement just-in-time and other continuous improvement concepts while retaining a traditional responsibility accounting control system? Although the jury is still out on this question, a number of field research studies indicate that accounting based controls are playing a decreasing role in companies that adopt the lean enterprise concepts. In a recent study involving nine companies, each company answered this controversial question in a different way by using a different mix of process oriented versus results oriented learning and control information.2 Since each company is different, a generalized answer to this question for all firms in all situations cannot be provided.
For example, the cost of rent can be assigned to the person who negotiates and signs the lease, while the cost of an employees salary is the responsibility of that persons direct manager. This concept also applies to the cost of products, for each component part has a standard cost (as listed in the item master and bill of materials), which it is the responsibility of the purchasing manager to obtain at the correct price. Similarly, scrap costs incurred at a machine are the responsibility of the shift manager. By using this approach, cost reports can be tailored for each recipient. For example, the manager of a work cell will receive a financial statement that only itemizes the costs incurred by that specific cell, whereas the production manager will receive a different one that itemizes the costs of the entire production department, and the president will receive one that summarizes the results of the entire organization. As you move upward through the organizational structure, it is common to find fewer responsibility reports being used. For example, each person in a department may be placed in charge of a separate

cost, and so each one receives a report that itemizes their performance in controlling that cost. However, when the more complex profit center approach is used, these costs are typically clumped together into the group of costs that can be directly associated with revenues from a specific product or product line, which therefore results in fewer profit centersthan cost centers. Then, at the highest level of responsibility center, that of the investment center, a manager makes investments that may cut across entire product lines, so that the investment center tends to be reported at a minimal level of an entire production facility. Thus, there is a natural consolidation in the number of responsibility reports generated by the accounting department as more complex forms of responsibility reporting are used.

Planning & control are essential for achieving good results in any business. Firstly, a budget is prepared and, secondly, actual results are compared with budgeted ones. Any difference is made responsibility of the key individuals who were involved in (i) setting standards, (ii) given necessary resources and (iii) powers to use them. In order to streamline the process, the entire organization is broken into various types of centers mainly cost centre, revenue centre, profit center and investment centre. The organizational budget is divided on these lines and passed on to the concerned managers. Actual results are collected and displayed in the same form for comparison. Difference, if any, are highlighted and brought to the notice of the management. This process is called Responsibility Accounting.

RESPONSIBILITY CENTRE

A FORMAL DEFINITION OF RESPONSIBILITY ACCOUNTING


Responsibility accounting involves the creation of responsibility centres. A responsibility centre may be defined as an organization unit for whose performance a manager is held accountable. Responsibility accounting enables accountability for financial results and outcomes to be allocated to individuals throughout the organization. The objective is to measure the result of each responsibility center. It involves accumulating costs and revenues for each responsibility

centre so that deviation from performance target (typically the budget) can be attributed to the individual who is accountable for the responsibility centre.

What is responsibility accounting?


Responsibility accounting involves a companys internal accounting and budgeting. The objective is to assist in the planning and control of a companys responsibility centerssuch as decentralized departments and divisions. Responsibility accounting usually involves the preparation of annual and monthly budgets for each responsibility center. Then the companys actual transactions are classified by responsibility center and a monthly report is prepared. The reports will present the actual amounts for each budget line item and the variance between the budget and actual amounts. Responsibility accounting allows the company and each manager of a responsibility center to receive monthly feedback on the managers performance.

n order to make the organization working at its best and reaching its potential to achieve objectives, the actual results are compared with the targets. And if those targets are not achieved someone must be held responsible. Because without accountability we cannot control business operations and cannot ensure the effective and efficient achievement of business objectives.
This system of accountability that will be implemented at different locations inside an organization is called responsibility accounting.

Most of the time when the aspect of responsibility is discussed, many people think of holding somebody responsible for failures. But responsibility does not only mean identifying and relating only failures but it also includes identification of success and finding who made this achievement possible. So the system of accountability is not only used to penalize but also to reward the staff.
But before any entity decides about the punishment and rewards, it must decide how responsibility is determinedand the extent of responsibility. In order to implement responsibility accounting system effectively and to hold managers accountable for their actions two things must be decided: Role of the manager i.e. what he is required to look after which will be determined by the type of responsibility center in which he is working and he will be held responsible just for that. This basically defines the authority of the manager i.e. his powers. Ability to exercise the authority i.e. whether he had the reasonable time to act and the circumstances favourable for application of his powers. These two aspects are collectively referred as Principle of controllability. This principle dictates that managers should be held only responsible against such costs, revenues, profits or other basis of performance measurement which were in their control. Managers should not be questioned for anything that was beyond their control. There are many reason why we should not be holding them responsible for uncontrollable aspects. Two of them are demotivation and dissatisfaction towards task and management respectively.

Therefore, we need a system through which roles and duties of managers are defined and also which has the capability to assess the second bit of controllability i.e. whether manager

has the ability to exercise his powerswhich is really not easy.

Roles are defined by dividing the organization into different responsibility centers:
Cost center where managers are responsible only for the costs incurred Revenue center where managers are responsible only the revenues generated Profit center where managers are responsible for both costs and revenues. We can understand that profit center manager will be responsible for both costs and revenues because he will have both cost and revenue centers under him and this managers at cost and revenue centers are subordinate to profit center manager. Investment center where managers are responsible for making decisions regarding investments. As decisions regarding investments are made on the basis of profits earned thus profit center manager works as a subordinate to investment center manager.

We can understand the scope of authority each responsibility center has over the other and the extent of decision making by understanding how they are connected with each other in the form of different layers of management. Remember each layer has its own degree of influence and as we move upwards, the capacity to influence increases as authority is increasing.
Cost and revenue centers basically resides in operational layer of management where as moving one step above we have profit center which is basically tactical layer of management and moving even further above we have strategic layer of management where managers are responsible to make important long term decisions that are crucial and important to the organization. Have a look at the following figure to easily understand how responsibility centers are connected with each other.

Angle of incidence: Ans


What is the Meaning of Angle of Incidence?
Answer: ANGLE OFINCIDENCE: Angle of incidence is formed at the inter-section of total cost line and total sales line. As a matter of fact there are two angles of incidence. (i) (ii) the angle formed at the right side of the break-even point. the angle formed at the left side of the break-even point.

The angle formed at the right side of the break-even point indicates the profit area while that formed at the left side indicates the loss area. The size of the angle of incidence is indication of the quantum of profit or loss made by the firm at different output/sales levels. For example, if the angel of incidence is narrow to the right side of the BEP it indicates that the quantum of profits made by the firm is also low. Similarly, if it narrow to the left side of the BEP it indicates that the quantum of loss made by the firm is also low. In other words, a narrow angle of incidence shows a slow rate of profit earning while a wider angle of incidence indicates a swift rate of profit earning capacity of the firm. A narrow angle also indicates that the variable cost as a proportion to sales is quite high and therefore very little has been left by way of contribution.

A study of angle of incidence, break-even point and margin of safety can help the management in having a better understanding about profitability, stability and incidence of fixed and variable costs on the performance of the firm. This can be understood by taking the following four different situations:

ANGLE OF INCIDENCE (q)


This is the angle between the lines of total cost and total revenue. Higher is the angle of incidence, faster will be attainment of considerable profit for given increase in production over BEP. Thus, the higher value of q makes system more sensitive to changes near break-even-point. An indirect (numerical surrogate) measure of Q is profit volume ratio. This is defined as: Profit Volume Ratio = Sales - Variable Costs/ Sales Higher is the profit volume ratio, greater will be angle of incidence and vice-versa.