4 Marginal Costing and Throughput Accounting Flashcards
marginal cost
part of the unit cost that would be avoided if unit was not produced
contribution
= sales - variable cost of sales
profit per unit varies with volume, contribution per unit is constant
marginal costing
alternative method to absorption costing: all fixed costs are period costs and are the same for any volume within relevant range; inventory valuation uses only variable production costs, unit costs are all variable costs. Profit measurement based on contribution.
marginal vs absorption costing
- if there is a change in inventory in period, absorption costing will produce different profit than marginal costing —> reconciliation: ∆inventory x absorption rate,
- this difference is only in the short term (fixed costs shifted between periods), in long term same result,
arguments for absorption costing
fixed costs incurred to produce output = „fair” to absorb them; inventory valuation in line with IAS 2; consistent with accruals concept; makes possible to ascertain if fixed costs are covered (useful when fixed costs are large) - something contribution does not allow.
arguments for marginal costing
simple to operate; no subjective apportionments, fixed costs are same regardless of activity level so it makes sense to charge them to period; under/over-absorption avoided; best information for decision making; avoids fallacy of overproduction that allows to hide costs in absorption = same profit regardless of production volume.
Marginal costing vs ABC
as marginal only discerns between variable and fixed costs, it’s only useful for short term decision making. Some costs have cost drivers independent from level of activity and not taking them into account may lead to incorrect long-term decisions. The advantage of ABC is that it spreads costs across products according to number of different bases. Marginal would not link costs to products and give wrong impression on the long-run average costs of products (nie wiadomo w jaki sposób baza kosztów stałych jest powiązana z działalnością operacyjną).
full cost plus pricing
- full cost incl. absorbed overheads + profit %; useful for contract / jobbing work where prices have to be quoted often but need to cover fixed costs,
- fails to recognize profit-maximizing price/demand combination,
- may be out of touch with demand and competition,
- budgeted output necessary to establish absorption rates - key factor,
- suitable rates need to be selected,
- quick, simple and cheap, useful for junior staff when prices have to be quoted, safer prices to cover fixed costs,
- concerned with net profit.
marginal cost plus (mark-up) pricing
- variable costs + profit %; useful for businesses with easy to recognize variable cost (retail),
- simple and easy to use,
- markup % can be varied to suit external conditions,
- concerned with gross profit (contribution) = draws management attention to maximizing cont.,
- does not automatically ensure attention is paid to competition, demand and covering fixed costs,
- more appropriate for use in one-off pricing decisions,
- ignores fixed costs.
Theory of constraints (TOC)
Production system / Procedure for dealing with binding constraints (bottlenecks) and achieving even workflow. Key concepts: turn materials into sales ASAP (zero inventory), balance in production (even workflow), continuous improvement (new constraint identified as old one solved). Steps:
- Identify bottleneck,
- Exploit - achieve highest possible output from it. Buffer inventory should be held directly before it to ensure work never stops here,
- Subordinate - operations before bottleneck work at same speed to avoid queues,
- Elevate - remove bottleneck by improving efficiency or increasing available resources,
- Back to step 1 (cont. loop)
Aim of TOC: maximize throughput while keeping conversion and investment costs at minimum.
Constraint
activity, resource or policy that limits the ability to achieve objective
Throughput contribution
= sales revenue - direct material cost
Conversion cost
= all operating costs except materials
Investment cost
= inventory, equipment etc. (CAPEX)
Throughput accounting
Accounting system based on TOC and JIT. Measures throughput contribution per factory hour. Similar to marginal costing but useful for long-term decision making. Emphasis:
- Throughput - in modern production environment, most costs incl. labour are fixed in short term. Therefore the objective of manager is to make best use of the base he has = maximize throughput. TA combines all conversion costs together, so it’s well suited to go with ABC for deep cost analysis.
- Inventory minimisation - ideal inventory of zero, this means idle time has to be accepted (except for bottleneck),
- Cost control - profitability measured by rate at which sales are made —> how quickly goods are made to satisfy demand. Just producing output does not create profit, so inventory valued at material cost only.
