3. Marginal Costing Flashcards
Define marginal costing
The variable cost of a product or a service - cost that would be avoided if the unit was not produced or provided
Define Period costs
Costs relating to a time period rather than the production of a product/service
What is meant by contribution
contirbution towards profit
What is the formula for contribution
Contribution per unit = selling price per unit - all variable costs per unit
Total contribution = total sales revenue - total variable costs
How do you work ut the difference between two absorption profit and marginal cost figures
OAR per unit x Change in inventory
In which case would you profit for absorption cost be higher than cost
S: stocks
I: Increase
A: absorption profit
M:more
Or
When sales = production, inventory is constant so AC Profit = MC profit
When Sales > production, inventory is falling so AC Profit < MC profit
When slaes < production, Inventory is increasing so AC > MC profit
What are the advantages of marginal costing
- Most appropriate for decision making due to contribution
- Good for short term
- Fixed costss are treated with nature as period costs
- Profit depends on sales and efficiency not production
- Slightly simpler variance analysis
What are the disadvatages to marginal costing
- Products will be sold on ongoing basis at marginal contribution which fails to cover fixed costs
- Does not comply with IAS 2 inventories so requirements year end adjustments
- Necessitates analysis of mixed costs between fixed and variable
- Seasonal variations in year can cause unecssary profit variances
Compare MC and AC
- MC is commonly used for decision making in the short term
- ABC and AC give a more accurate product profitability breakdown
- MC may provide incorrect decision making information especially when fixed costs are large compared to variable
What is meant by full cost plus pricing
This is a method of determining the sales price by calculating the full cost of the product and adding a percentage mark up for profit
What are the issues with using full cost plus prices
- Fails to recognisse demand may determine price : profit maximising combination of price and demand
- Adjust prices to market and demand conditions
- Budgeted output volume needs to be established to work out OAR
- Suitable basis for Overhead absorption must be selected
What is meant by marginal cost plus/ mark up pricing
Method of determining the sales price by adding aa profit margin onto either the marginal cost of production or marginal cost of sale
How do you work out marginal cost
Total variable costs
What are the advatages of marginal cost plus pricign
- Simple and easy
- Mark up percent can be varied to reflect demand
- Draws management attention to contribution
- Used where there is readily identifiable basic variable cost
What are the disadvatages of marginal cost plus pricing
- Does not ensure sufficient attention is paid to demand conditions competitiors prices and profit maximisaiton
- Ignores fixed overheads
What are the four Cs when cosnidering price
- Customer: what are customers willing to pay
- Cost: how much it costs to make
- Competition: what are competitors charging
- Corporate strategy: what are company’s aim
Define theory of constraints
A production system where key financial concept is the maximisation of throughput while keeping conversion and investment costs to a minimum
- Minimise throughput time or maximise speed
What is throughput time
Time taken to convert raw materials into finished goods
What constraints are focused on TOC
Bottlenecks - act as a barrier to throughput maximisation
What is Goldratt’s five steps for dealing with bottleneck activity
- Step 1: Identify: binding constraint/bottleneck
- Step 2: Exploit: the highest possible output achieved from binding constraint and hold buffer inventory for this
- Step 3: Subordinate : operations prior to binding constraint should ooperate at same speed so WIP does not build up
- Step 4: Elevate: systems by taking steps to increase resources
- Step 5: Return: to step 1 to remove bottleneck created elsewhere
How do you work out Throughput contribution/return
Sales revenue - direct material cost
How do you wokr out conversion cost
All operating costs except direct material costs (all costs except totally variable costs)
Explain features of Throughput accounting
- Used for longer term decision making about production capacity
- JIT environment
- WIP is valued at material cost only as no value is added until profit is made
- only variable cost is materials - all other factory costs are fixed including labour
- Profit is determined by rate at which throughput can be generated: how quickly raw materials is turned into sales
What ratios are important in Throughput return accounting
- throughput return per factory hour
- total factory costs per period
- throughput cost per factory hour
- throughput accounting ratio
