Marginal Costing Techniques: It’s Effectiveness As Managerial Tool For Profit Planning And Decision-Making In Manufacturing Companies (A Case Study Of Selected Manufacturing Company In Ilorin, Kwara State)
All over the world, business are set up ultimately to make and maximize profit. Effective planning is sino-qua-non to the attainment of this objective. Since profit is the “Life Wire” of any organization, it becomes expedient that such profits be planned for and by doing, decisions capable of affecting the long term efficiency of the business are made.
This study is carried out to test the effectiveness of marginal costing techniques as a management tool for profit planning and decision making in manufacturing companies. Two hypothesis were tested on the effectiveness or otherwise of marginal costing technique and the relationship between three significant valuable (cost, volume and profit) in profit planning and decision making
The finding of the analysis carried out suggested that marginal costing is a vital tool in the area of profit) planning and solid decision making.
However, marginal costing technique is not totally independent and therefore should not isolated from other techniques. The combination of the techniques with other powerful techniques such as budgetary system, overhead absorption costing e.t.c. will produce a better result.
Finally, for marginal costing techniques to serve its purpose there are a number of limiting assumption upon which it is based and these must be fully recognized.
Table of Content
- Title Page
- Table of Content
- 1.1 Introduction
- 1.2 Background of the Study
- 1.3 Statement of Research
- 1.4 Justification of the Study
- 1.5 Objective of the Study
- 1.6 Statement of Hypothesis
- 1.7 Scope of the Study
- 1.8 Definition of Term
- 1.9 Plan of the Study
- 2.1 Introduction
- 2.1.1 Stock Valuation and Operating Under Marginal Costing
- 2.1.2 The Difference between Marginal Costing and Other Related Concept. Absorption Costing.
- 2.2 Development of the Basic technique Used in Marginal Costing Approach
- 2.2.2 Integration of Cost Accounting and Financial Accounting
- 2.3 Cost Volume-Profit (C.V.P) Analysis; An application of marginal Costing.
- 2.3.1 Approaches To Cost-Volume Profit Analysis
- 22.214.171.124 Equation/Mathematical Approach
- 126.96.36.199 Contribution Margin/Unit Approach
- 188.8.131.52 Contribution Margin for the Approach
- 184.108.40.206 Graphical Approach
- 2.3.3 Criticism and Limitation of Cost-Volume Profit Analysis
- 2.3.4 Importance and Application of Cost Volume Profit Analysis
- 2.4 Conclusion
- 3.1 Introduction
- 3.2 Research design
- 3.3 Population of the study
- 3.4 Source of Data
- 3.5 Sampling Method
- 3.6 Data Collection
- 3.7 Data Analysis Procedures
Analysis and Interpretation of Data
- 4.1 Introduction
- 4.2 Regression Analysis
- 4.2.1 International Tobacco Company Plc; Manufacturing Cost Progression Analysis
- 4.2.2 (a) International Tobacco Company Plc; Operating Profit Progression Analysis
- 4.2.3 (b) 7up Bottling Company, Ilorin Operating Profit Regression Analysis.
- 4.3 Test of Hypothesis and Interpretation of Result
- 4.3.1 Hypothesis One
- 4.3.2 Hypothesis Two
- 4.4 Summary of the Result Finding
Summary, Conclusion and Policy Recommendation
- 5.1 Introduction
- 5.2 Summary
- 5.3 Conclusion
- 5.4 Recommendation
Marginal costing techniques plays an important role in a manufacturing companies and also have effectiveness as a managerial tool for profit planning and decision making in manufacturing companies, in which over the years have been used by management cadire in planning the profit of an organization and had also served as a necessary tools in management decision making especially in the short-run.
The ultimate goal and objectives of any business organization is to make and maximize profit. This technique place emphasis on the separation of cost into their fixed and variable component hence, there is no clear out dichotomy between cost, volume and profit at different level of activities, where can be a useful guide in short term planning and decision making.
Marginal cost can be best applied to the following areas:
Profitability of Department or Product:
Marginal costing form is very useful for determining whether or not a department should continue to operate or whether a product should be eliminated.
Profit is not just accidentally or just a matter of luck. It must be purposely and deliberately planned for. According to Stephen A. Moscow.
Reporting to Management:
Marginal costing techniques cal also be used for both internal and external report to be and middle management.
The main purpose of a report is to take any necessary corrective action or measure which will take the form of control.
Controlling can be used to achieve reporting function. The fact that controlling is useful for reporting lie, on the fact that before accounting result can be reported to the management, the concerned department must have made attempts to control the solution before reporting to the management for the final decision making.
1.2 Background of the Study
The success of any entity is measured in terms of the accomplishment. Its goals and objectives “A business objective is the study point business thinking and it provides direction for action and is also a way of measuring and effectiveness of action taken”.
The ultimate goal and objectives of any business organization is to make and maximize profit. Profit itself can be defined as the excess of total income over total cost incurred in the procurement of that income through other objectives such as maximizing shareholders wealth, turnover and benefit to employee are usually taken into consideration; maximum profitability is usually the ultimate goals because it ensures economic natural selection. That is, people will naturally proffer to invest in business with high profitability and on the long run, only profit maximizers survive the business environment.
Also worthy of note is the fact that, the achievement of any goal starts with planning. Since profit is a “Life-Wire) of any business organization, its profit to a large extent depend on the ability of the management to plan, organize, co-ordinate and execute policies effectively and product future situation and conditions. In profit planning, the enterprise decides the amount f profit it wards to make within a specified period of time and then carries out a feasibility study to determine what sales and activity base are needed to provide that profit within the limit of the resource available to the company, it’s strength and weakness and the threat it faces from its competitors.
Management at all cadres carryout plans to facilitate decision making on the other hand involves the process of identifying and selecting of course of action among alternatives to deal with a specific problem or take advantages of an opportunity. Many factors both qualitative need to be considered and for many decisions financial information is a critical factor.
Decision-making can be viewed as a three fold actually involving:
- Identifying a Problem
- Analyzing the data and
- Choosing a suitable decision rule.
These three activities collectively have an important bearing in accounting reports, which are used literally by management as well as by external users.
Marginal costing techniques had over the years been used by top management cadre in planning the profit of an organization and had also served as a necessary tool in managerial decision making especially in the short-run. It is defined as “The accounting system in which variable cost are charged to cost units and fixed cost of the period are written-off in full against the aggregate contributions”. It is of special value in decision making.
This techniques place emphasis on the separation of cost into their fixed and variable component hence, there is no clear cut dichotomy between marginal cost techniques and the cost volume-profit analysis except that while the former is dynamic, the later is static. As a matter of fact, cost-volume-profit analysis is an application cost, volume and profit of different level of activities, which can be a useful guide in short term planning and decision making.
1.3 Statement of the Problem
Despite the general acceptance and frequent use of marginal costing techniques, many establishment to adopt the techniques in some of its planning and decision making area. The reason for this development might vary from company to company.
Also, there are arguments as to the validity of marginal costing techniques in a real business situation into consideration putting into consideration. The assumptions surrounding it. These assumptions are:
- That selling price of product without vary it different levels of output.
- That the production capacity of the plant will remain fairly constant
- That efficiency of operation will be constant whether or not these assumption can remain true or be valued in real business situation call for a research.
Most especially, there is dichotomy between the economical and the accountant’s view of marginal (or variable) cost. This has to do with the unit cost, volume of production, and profit. While the economist assumed a curvilinear relationship, the accountant assumed a linear relationship (the reasons for this difference in opinion will be discussed a linear relationship (the reasons for this difference in opinion will be discussed in the literature review).
However, this prompts the research to look into the books and records of selected manufacturing companies, to establish whether there is any relationship whatsoever between costs, volume and profit, and the nature of the relationship there of.
Other problem area in the application of marginal costing techniques are:
1. Separation of Costs:
It is possible for the management to misjudge the behavior or cost in that, the split made between fixed and variable costs could be sometimed unreliable and that could lead to enormous conclusion. The begaviour of cost in relation to changes in the level of activity is so important that it forms the basis of the accounting classification of cost into fixed and variable costs.
2. Variable Cost Rate Per Unit:
The accountant’s view of the variable cost for unit could be in advertently misleading.
This is due to the following reasons
- Change in operating condition, for instance, from a one shift to a double shift per day situation.
- The principle and application of the learning curve theory.
- Change in the pattern of production range.
- The state of the machine, level of motivation for labour and quality of resources available, goes a long way in determining the number of hours to produces a unit of a particular product.
Considering the assumption underlying the application of marginal costing techniques, the diver genus in views and opinions between profession in respect to the relationship between the variable (cost, volume and predict) all of which are major factor in the application of the techniques, and the other difficulties in the application such as; separation of costs and the determination of the variable cost rate per units, calls for the need for the researcher to establish whether the costing techniques had in anyway been effective as a marginal tools in profit planning and decision making.
1.4 Justification of the Study
Through the concept of marginal costing techniques had been adopted by many establishment, the assumption couple with other difficulties in its application as mentioned under the statement of the problem, justified the need of this study. Despite these limitations, the appraisal of the techniques proves that his reliable and effective as a managerial tool for profit planning and short-run decision making.
Other areas that make this research significant are:
- It serve as a guide to the management of any manufacturing company in making effective plans geared towards profit making and also making sound and effective decisions relating to the following problem.
- The analysis of cost, volume and profit
- Determining of the product mix when a company is faced with constraints
- The finding of this research work is capable of giving the “would be” managers and students in particular, an insight into what marginal costing technique involves. It could be trigger another research on the costing technique as it regards, planning of profit and the making of decision especially in the short-run.
1.5 Objective of the Study
The main objectives of this study is to examine the extent to what marginal costing is used by the management of the selected manufacturing companies as a managerial tool in profit planning and decision making and how effective it has been in planning such profits.
The objective can further be broken down to include the following:
- To determine whether there is any relationship between costs, the level of activity and the profit made by firms.
- To determine if this interrelationship (if any)) can be used to effectively plan the profit of the firm or not.
- To observe the effect of profitability on volume and seek to determine whether there are other factors other than volume of activity that affects profitability and how such factor affect the behavior of cost and profit.
- To analyze in a descriptive manner, the important of marginal costing techniques in the making of decisions.
- Lastly, to proffer suggestions on the application of the technique of marginal cost taking into account its assumption
1.6 Statement of the Hypothesis
In order to determine the relationship between variable (cost, volume and profit) and the extent of use and effectiveness of marginal costing techniques as a marginal tool for profit planning and decision making, call for investigation in the selected manufacturing companies and the following hypothesis were tested.
Ho: That there is no relationship between production cost, the level of activity and profit.
H1: That there is relationship between production cost, the level of activity and profit.
Ho: That marginal costing technique is not effective as a managerial tool for profit planning and decision making in manufacturing companies.
H1: That marginal costing technique is effective as a managerial tool for profit planning and decision making in manufacturing companies.
- Ho Null hypothesis
- H1 Alternative hypothesis
1.7 Scope of the Study
This research is based on three non-randomly selected manufacturing companies within Ilorin. The three company cut across various industries like; Bottling, Tobacco, to allow for good representation. The decision to use more than one manufacturing company is bourn out of the desire to make a good generation from the conclusion draw from the study. The raw date used for the research work is collected from the production, accounting, sales and costing department of each of the company for ten year covering 2004-2013).
For the purpose of this research, costs are separated into first and variable costs. Management policies, techniques method and efficiency of employees and machine are assumed constant.
1.8 Definition of Terms
Marginal cost viz-a-viz break even analyze is an analytical technique for studying the interrelationship between costs (fixed and variable), volume and profit at different level of activity. The researcher fined it exponent to define these concepts and other related ones, to enhance a better understanding of the subject matter.
T. Lucey defined cost as “the account of expenditure (actual or natural) incurred on, or attributable to, a specified thing or actually”. The two types of cost in perspective in this study are:
The fixed cost of any organization according to Lucey is “A cost which accrues in relation to the passage of time and which within certain output and turnover limit tend to be unaffected by fluctuation in the level of activity”. Examples are: rent rate, insurance and license fees on automobiles e.t.c.
It is a unit used to measure the level of activities. This unit of measurement is called the volume index.
This is the excess of total income or revenue over the total cost or expenses incurred in the procurement of that income. The component of profit are:
This imply the excess of net revenue from sales over the cost of goods sold. It is termed gross profit because operating expenses must be deducted from it. i.e.
- Gross Profit= Net Sales – Cost of Goods Sold
- Net sales= Total sales- Good Returned Inwards
- Cost of Goods Sold=Opening Stock+Purchase- Closing Stock
It s the excess of revenue over the expenses incurred in earning that revenue, i.e.:
Net profit= gross Profit- Operating Expenses
Where, operating expenses= Selling Expended Administrative Expenses other expenses (operating) in a period.
This is the term given to the differences between sales and marginal (variable) cost.
The summation of cost of indirect labour, indirect material and indirect expenses is referred to as; overhead.
1.9 Plan of the Study
The research project consists of five chapters.
In this first chapter, the general background nature of the study, i.e. an over view of marginal costing techniques is looked into.
The second chapter which is the Literature Review is broken down to include the following:
- The development of the basic technique used in the managerial cost approach
- Cost-volume profit analysis as an application of managerial cost approach
- The use of managerial costing technique
The third chapter is the research methodology; it deals with the methods the researcher used in collecting data and also the procedure which the analysis follows.
The analysis of the data collected from the various companies used as case study based on the subject matter in relation to profit planning and decision making is done in this chapter.
The data is analyzed following the order as described in chapter three.
The fifth and the last chapter deals with the summary of the findings, conclusion would be drawn on the research problems and recommendation made where necessary.
Summary, Conclusion and Policy Recommendation
After gathering and analyzing the various data and limitation for the study, his prevent at this point to collate and summarize the results of the study with the aim of arriving at operational conclusion and thus offer useful recommendation (where necessary) to the management of the selected companies in respect of the application of marginal costing technical department/products.
This study actually and objectively assessed the principle of marginal costing technique by determining whether or not the technique is effective as a managerial tool for profit planning and decision making most especially in the short-run.
The chapter two, which is the Literature review comprises of an elaborate introduction, the development of the basic technique used in application of marginal costing and finally the use of marginal costing.
The research methodology used for data collected and analysis were discussed in the chapter three and these include the administration of questionnaire, regression analysis, product moment correlation and the sequent t-test.
The data analysis of the study was based on the response to the questionnaire administrative and the internal records of the selected companies. For analytical purposes, some models were used to test the hypothesis formulated and the result were interpreted accordingly.
From the findings of the data and the information in chapter four, it may be concluded that:
- Marginal costing techniques is very effective as a managerial tool for profit planning and short-run decision making
- There is a significant relationship between cost, volume of activity and profit and make marginal costing a vital tool in the hand of management in planning the target profit and hence the level of activity there of.
- Marginal costing technique seems to offer more than the alternative costing method in terms of presentation of information.
- Marginal costing technique will quote a lessor prices for a product than absorption costing technique in price determination.
Due to the small number of sample selected, it may be difficult to make a universal generalization. However, it can thus be calculated that for efficient use of the approach (marginal costing) it should be used in connection with the traditional overhead absorption costing method and/or budgeting techniques to improve its effectiveness.
This investigation of the effectiveness for marginal costing techniques as a managerial tool for profit planning and decision making came as a result of the need to increase the general understanding of the topic through a detailed research work.
International Tobacco company which lither to had been using other techniques aside marginal costing in most of its profit planning and decision making seem to have come to term with the advantageous position of marginal costing and hence the change in policy. However, the following recommendations are made in view of the finding from the selected companies and review of related interests.
- Marginal costing not to regard as the only tool for profit planning and decision making. In other words, the technique should be used alongside other powerful too such as budgeting system and the over head absorption costing method.
- The use of marginal costing in separation of fixed and variable costs is based on a number of limiting assumptions
- Since income determination is directly connected to inventory valuation, any change in stock valuation will affect profit. In the light of this, the focus should be the relationship between sales, volume and profit which can be said to be closer under marginal costing than in any other technique.
- Management at all time should view absorption costing as an extension rather than a substitute of marginal technique costing.
- Separation of fixed and variable cost should be based on least square method because the marked will provide better and more reliable result compare to every other methods of cost separation.
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