4. Marginal Costing & Absorption Costing Flashcards
What are the two methods of costing we will look at?
- Absorption costing
- Marginal costing
What is absorption costing?
With absorption costing, both variable and fixed production costs (material, labour and overheads) are included in the valuation of cost units.
Under absorption costing, how is inventory of finished goods valued?
Under absorption costing inventory of finished goods is valued based on the full production cost of those units (including absorbed fixed production overheads).
Outline the long form of the pro-forma to calculate profit using the absorption costing method
Outline the short form of the pro-forma to calculate profit using the absorption costing method
What is marginal costing?
Marginal costing is an alternative costing system to absorption costing.
With marginal costing, only variable production costs (material, labour and overheads) are included in the valuation of cost units.
All fixed costs are treated as period costs and are charged in full in the income statement for the period.
What is contribtuion with regards to marginal costing?
Contribution is the difference between sales value and marginal (or variable) cost
Outline the equation for calculating contribution per unit
Outline the pro-forma for calculating contribution per unit
Outline the equation for calculating total contribution
Outline the equation for calculating marginal production cost per unit
Under marginal costing, how is inventory of finished goods valued?
Under marginal costing inventory of finished goods is valued based on the variable production cost of those units (excluding any fixed production overheads).
Outline the long form of the pro-forma to calculate profit using the marginal costing method
Outline the short form of the pro-forma to calculate profit using the marginal costing method
Summarise the main differences between the two costing methods? (3)
Outline the formula that gives the difference in profit between the marginal costing method and the absorption costing method
Change in inventory is closing inventory less opening inventory
Under what conditions will absorption profits be greater than marginal profits and vice versa?
- In periods where inventory levels rise, Absorption profits > Marginal profits
- In periods where inventory levels fall, Marginal profits > Absorption profits
Outline the handy shortcut method for calculating absorption profit given the marginal profit
1) With the marginal profit to hand, determine the change in inventory and the OAR per unit
2) Rearrange the formula as shown and using this eqaution plug in the numbers to get the absorption profit
Outline the handy shortcut method for calculating marginal profit given the absorption profit
1) With the absorption profit to hand, determine the change in inventory and the OAR per unit
2) Rearrange the formula as shown and using this eqaution plug in the numbers to get the absorption profit
Outline the advantages for both absorption costing (3) and marginal costing (6)
Advantages of absorption costing
1. Fixed production costs are incurred in order to make output; it is therefore ‘fair’ to charge all output with a share of these costs.
2. 2. Closing inventory values, by including a share of fixed production overhead, will be valued on the principle required by accounting standards for the financial accounting valuation of inventories for external reporting purposes.
3. A problem with calculating the contribution of various products made by a company is that it may not be clear whether the contribution earned by each product is enough to cover fixed costs, whereas by charging fixed overhead to a product it is possible to ascertain whether or not it is profitable.
Advantages of marginal costing
1. It is simple to operate.
2. There are no apportionments of fixed costs, which are frequently done on an arbitrary basis. Many costs, such as the managing director’s salary, are indivisible by nature.
3. Fixed costs will be the same regardless of the volume of output, because they relate to a period of time and are period costs. It makes sense, therefore, to charge them in full as a cost to the period.
4. The cost to produce an extra unit is the variable production cost. It is realistic to value closing inventory items at this directly attributable cost.
5. Under or over absorption of overheads is avoided.
6. Marginal costing information can be more useful for decision-making since it focuses on the variable costs that are most likely to be altered as the result of a decision.
