Question 5 (a)
Marginal and differential costing; imputed and opportunity cost; relevant and irrelevant cost
12 marks
- Time to write
- About 24 minutes
Question
Question 5 (a) · 12 marksFor each pair, state the differences between the two: (12)
Differential costing; Marginal costing.
Opportunity cost; Imputed cost.
Relevant cost; Irrelevant cost
Reworded from the university paper; the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- (i)–(iii)3 items, each marked on its own: give each its share.
- differences betweenSet the differences out in a table, basis by basis, not as two separate essays.
What the paper leaves open
Part (a) shows "(12)" beside its opening line; as (b) carries 6, the 12 marks are taken to belong to (a).
Write it in this order
The parts stand alone: start with the one you are surest of.
- Read; underline the asks; jot your points 2 min
- 1 Marginal and differential costing 4 marks 7 min
- 2 Imputed and opportunity cost 4 marks 7 min
- 3 Relevant and irrelevant cost 4 marks 6 min
- Check: every ask answered, key terms underlined 2 min
Short on time? A few lines on every part beat a full answer to one: each part is capped at its own marks.
Try it first. About 24 minutes for 12 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
(i) Differential costing and marginal costing
Differential costing is the study of the difference in total cost (and revenue) between two alternatives, used to decide between them. Marginal costing is a technique in which only variable costs are charged to products and fixed costs are written off as period costs; it is used for cost-volume-profit analysis, pricing and product-mix decisions.
| Basis | Differential costing | Marginal costing |
|---|---|---|
| Nature | A technique of analysis for a particular decision | A system of costing and of presenting profit |
| Costs considered | All costs that change between alternatives, fixed or variable | Variable costs only; fixed costs excluded from product cost |
| Fixed costs | Included if they differ between alternatives | Always treated as period costs |
| Use in accounts | Not part of the accounting records; ad hoc | Can be incorporated in the accounting system |
| Measure | Differential cost and differential revenue | Contribution |
| Example | Cost of expanding output from 70% to 90% capacity, including a new shift supervisor | Contribution of each product per machine hour |
(ii) Opportunity cost and imputed cost
Opportunity cost is the benefit given up by choosing one alternative over the next best: the value of the alternative forgone. Imputed (notional) cost is a hypothetical cost that does not involve any actual payment but is charged to make a comparison fair: for example, interest on the proprietor's own capital, or rent for premises the business owns.
| Basis | Opportunity cost | Imputed cost |
|---|---|---|
| Meaning | Benefit sacrificed from the best rejected alternative | Notional charge for using own resources |
| Purpose | Correct choice between alternatives | Fair comparison of performance or alternatives |
| Nature | Depends on the alternatives actually available | A specific charge, often interest or rent |
| Recorded in books | No | No (may appear in cost statements) |
| Example | A machine used for product X forgoes ₹30,000 contribution it would have earned on product Y | Interest at 10% on owner's capital of ₹5,00,000 = ₹50,000 |
(iii) Relevant cost and irrelevant cost
Relevant costs are future costs that differ between the alternatives under consideration; only they affect the decision. Irrelevant costs are costs that will be the same whichever alternative is chosen, or that have already been incurred, and so do not affect the decision.
| Basis | Relevant cost | Irrelevant cost |
|---|---|---|
| Time | Future cost | Past (sunk) or future but unchanged |
| Effect on decision | Changes with the decision | Same under every alternative |
| Examples | Variable cost of an extra order; additional fixed cost of a new shift; opportunity cost | Sunk cost of a machine already bought; allocated head-office overheads that continue anyway |
| Treatment | Included in decision analysis | Ignored |
All three pairs concern which costs should be considered in a management decision. Marginal and differential costing both look at costs that change, but marginal costing is a continuing system based on cost behaviour, while differential costing is a one-off comparison of two courses of action. Imputed and opportunity costs are both costs that do not appear in the financial accounts, but one is a fair charge for using one's own resources and the other the benefit sacrificed. The relevant-cost idea brings these together: in any decision, only the future costs and revenues that differ between the alternatives, including opportunity costs, should be counted, and sunk or common costs should be ignored. A manager deciding whether to accept a special order, for instance, compares the extra revenue with the differential cost of the order and any contribution given up, and ignores the fixed costs that will be incurred anyway.
Where the 12 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Marginal and differential costing | 4 |
| 2 | Imputed and opportunity cost | 4 |
| 3 | Relevant and irrelevant cost | 4 |
| Total | 12 |
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