CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
One of the most important things in life of a business is decision making. Decision making is an all pervasive activity taking place at every level in the organization, covering both the short and long term. It is concerned with the future and involves a choice between alternatives. The decision making of a business is centered upon the information possessed by the decision maker. However, plans are activated by decisions which require some of financial or qualitative analysis in order to make a rational choice. It is because of this that the practicing management Accountant is heavily engaged in producing relevant information for decision making purpose. The overall objective of a business enterprise is to make profit and as such, the decision on which method of reporting profit to be used at any given time is a very crucial management decision. In traditional costing, there is a very crucial and two basic method of reporting profits. The emphasis in this research will, however, be on the importance of marginal costing techniques in the decision making process. These are:
1. Absorption costing/ full costing
2. Marginal costing period costing/direct costing The practice of charging all costs both variable and fixed to operations, products or processes is termed as absorption costing. The practice of charging all direct costs to operations, processes or products and leaving all indirect costs to be written off against profits in the period in which they arise is termed as direct costing. The technique differs from marginal costing because some fixed costs can be considered as direct costs in appropriate circumstances. According to Browning, 2OOO) Marginal costing is a technique of costing in which allocation of expenditure to production is restricted to those expenses which arise as a result of production, e.g., materials, labor, direct expenses and variable overheads. Fixed overheads are excluded in cases where production varies because it may give misleading results. The technique is useful in manufacturing industries with varying levels of output. The features which distinguish marginal costing from absorption costing are as follows.
1. In absorption costing, items of stock are coasted 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.
2. 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:
1. Include some fixed production overhead costs incurred in a previous period but carried forward into opening stock values of the current period;
2. 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.)