Marginal Costing Techniques and its Application in Adama Beverages Limited

INTRODUCTION
Marginal Costing Explained

Marginal costs are variable costs consisting of labor and material costs, plus an estimated portion of fixed costs such as administration overheads and selling expenses. In companies where average costs are fairly constant, marginal cost is usually equal to average cost. However, in industries that require heavy capital investment such as; automobile plants, airlines, mines and have high average costs, it is comparatively very low. The concept of marginal cost is critically important in a company’s resource allocation because, for optimum results, management must concentrate its resources where the excess of marginal revenue over the marginal cost is maximum. Marginal cost is the change in the total cost that arises when the quantity of commodities produced has an increment by unit. That means the cost of producing one more unit of a good. In general terms, marginal cost at each level of production includes any additional costs required to produce the next unit. For example, if producing additional vehicles requires building a new factory, the marginal cost of the extra vehicles includes the cost of the new factory. In practice, this analysis is segregated into short and long-run cases, so that over the longest run, all costs become marginal.  

Features of Marginal Costing It is a method of recording costs and reporting profits; • All operating costs are differentiated into fixed and variable costs; • Variable cost are charged to product and treated as a product cost; • Fixed cost is treated as period cost and written off to the profit and loss Account. 

Benefits of Marginal Costs to Adama Beverages Limited There is no doubt, the benefits of marginal cost to a company like Adama Beverages Limited cannot be underrated because; it is very helpful in managerial decision making of the company. Management's production, cost and sales decisions may be easily affected from marginal costing if not carefully observed. It is a comprehensive and sophisticated method of planning and monitoring costs based on resource drivers. Selecting the resource drivers and separating the costs into fixed and proportional components ensures that cost fluctuations caused by changes in operating levels, as defined by marginal analysis, are accurately predicted as changes in authorized costs and incorporated into variance analysis. It measures the change in cost over the change in quantity. For example, if the company is producing 10 units of Faro Bottling Water at N1000 total cost, and steps up production to 11 units at N1200 total cost, the marginal cost is N200 since only the last unit of production is measured in order to calculate marginal cost of the one more unit. Marginal costing helps companies in measuring costs and benefits at a specific level of production and consumption, and as such, the company cannot, but recognize its importance in its day to day operations since it of success rate is determined by the decisions it makes based on its marginal evaluations.  

Application of Marginal Costing By effective use of marginal costing formulae, Adama Beverages Limited can apply marginal costing for managerial decisions in the following ways: 1. Managerial Decision Relating to Determination of Optimum Selling Price Determining the optimum selling price of any product or service is a very big challenge for a manager of any company because company wants to profit of each unit of any product or service. In marginal costing techniques, 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. 2. To Check the Effect of Reducing of Current Price on profit It is a known fact that in any competitive market, customers become kings. They want products at minimum price, and at times some of them may be funny enough to an extent that they will want almost every product to be offered to them free of charge. For instance, consumers download free video on YouTube, using their data plans instead of buying them with money in CDs and DVD, customers of entertainment industry watch free films and movies on YouTube instead of patronizing the artists by purchasing their videos and movies in DVDs. But on the other side, companies want to maintain profit and as such, managers will be in tension because it is not possible to maintain profit even after reducing price or when products have been given away free of charge like in the case of free videos on YouTube. But the good news is that if managers learn marginal costing techniques and use it effectively, they can check the effect of reducing current price on net profit; after this, they can decide to reduce production or increase production. It is the law of economics that variable cost is reduced by reducing units of production in same proportion, but when there is increase in production, fixed cost will decreases very fast due to constant nature. 3. Choice of Good Product Mix It may be possible that a 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, managers see which product is giving high contribution margin and give preference to that product whose contribution is higher. 1. Calculation of Margin of Safety Marginal costing can be utilized for calculating margin of safety. Margin of safety is the difference between actual sale and sale at break even point. According to marginal costing rules, production will follow sales. Suppose current sale is N 4, 00,000 and BEP is N 3, 00,000, margin of safety becomes N100000. If company's sale is less than margin of safety, then managers can take step to reduce both fixed and variable cost or increase prices. 2. 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 government, foreign companies or wholesaler as the case may be. At that time managers have to take decision at what limit, they can give discount to special customers. Marginal costing may help in making this type of decision.  

Advantages and Benefits of Marginal Costing Cost control: Marginal costing makes it easier to determine and control costs of production. By avoiding the arbitrary allocation of fixed overhead costs, management can concentrate on achieving and maintaining a uniform and consistent marginal cost. Simplicity: Marginal costing is simple to understand and operate and it can be combined with other forms of costing (e.g. budgetary costing and standard costing) without much difficulty. Elimination of cost variance per unit: Since fixed overheads are not charged to the cost of production in marginal costing, units have a standard cost. Short-term profit planning: Marginal costing can help in short-term profit planning and is easily demonstrated with break-even charts and profit graphs. Comparative profitability can be easily accessed and brought to the notice of the management for decision-making. Accurate overhead recovery rate: This method of costing eliminates large balances left in overhead control accounts, which makes it easier to ascertain an accurate overhead recovery rate. Maximum return to the business: With marginal costing, the effects of alternative sales or production policies are more readily appreciated and assessed, ensuring that the decisions taken will yield the maximum return to the business.  

Conclusion Marginal costing is a useful analysis tool which usually helps management make decisions and understand the answer to specific questions about revenue. Its place in determining company’s success rate cannot be over emphasized, and if Adama Beverages Limited can apply its principles as discussed in this article, the company will no doubt multiply its success rate in future as a result.  

References: 

1. Application of Management Techniques, by Vivek Shriram Mahajan, University of Mumbai, India. 

2. A Study On Marginal Costing In Godrej Consumer Product Ltd, by; 

*S. Siva; **Moses Joshuva Daniel and ***S. Shalini. 

*Asst Professor Dept. of Management Studies, Achariya School of Business & Technology Puducherry. **Asst Professor Dept. of Management Studies, Achariya School of Business & Technology Puducherry. ***Mba Student Dept. of Management Studies, Achariya School of Business & Technology Puducherry.  Photo Credit: Edu Resource