4: Marginal Costing & Absorption Costing Flashcards
What is a marginal cost, and what does it include?
The extra cost arising from producing one more cost unit or one more service
Valued at: prime cost plus variable production overheads
In what three ways does MC and AC differ?
Classification of fixed production costs
Inventory valuation (and therefore CoS and Profit)
Format of a P&L
What is contribution and how is it calculated?
How much of a unit ‘contributes’ to the fixed costs.
Once fixed costs covered, then profit!
Sales price
(Variable production costs)
(Variable non-production costs)
= CPU!
Contribution per unit is constant
How to calculate the total contribution?
CPU x units sold
What is the better system to use for short-term decision making?
Marginal costing
Many costs (in the short term) are assumed to be committed and unavoidable (like fixed costs). They should not be considered when making short term decisions
How to calculate profits from a marginal costing P&L?
Total contribution - fixed costs!
Remember: more units sold, more contribution, more profit!
How does expensing fixed costs work differently with MC and AC?
MC: fixed costs expensed in the period in which they are incurred
AC: expensed in the period the inventory is sold. This may be outside one period!
What method generally leads to higher profits?
Absorption costing
Higher Closing Inventory
Lower CoS
Higher Profit
What is the calculation for profit reconciliation?
Marginal costing profit
(Closing - opening) x OAR
———————————
Absorption costing profit
Can be positive or negative
In what situations are marginal costing and absorption costing higher profit, in comparison?
Inventory level rises - absorption costs higher
Inventory level falls - marginal costs higher
What are the advantages of absorption costing?
Fixed productions costs are significant part of total costs
Required for financial reporting
Under/over can identify inefficiencies
What are the advantages of marginal costing?
Simpler!
Avoids arbitrary allocation and absorption of overheads
Better for short-term
Profits only rise if sales rise
