5. Marginal Costing and Pricing Flashcards
What is marginal costing?
Assigning only variable costs to cost units while fixed costs are written off as period costs (also known as variable costing)
What is the definition of marginal cost?
Marginal cost is part of the cost of one unit of product or service that would be avoided if the unit were not produced or that would increase if one extra one were produced
What is greater, absorption cost or marginal cost?
Absorption cost (includes allocation of fixed overheads)
What is the calculation for contribution?
Sales value - variable cost of sales
At what level of contribution do we make a profit?
When contribution is greater than fixed costs
What do we use to reconcile between the profits or losses calculated under absorption and marginal costing?
Absorption costing profit
Add: Opening inventory x FOAR
Less: Closing inventory x FOAR
= Marginal costing profit
What is the simple calculation for difference in profit of absorption and marginal costing?
Movement in inventory x FOAR
If inventory levels are rising….
Absorption profit will be higher than marginal
If inventory levels are falling…
Marginal profit will be higher than absorption
What are the benefits of marginal costing?
Better for decision making, fixed costs treated as they are, profit depends upon sales activity and hence enables clearer performance evaluation
What are the disadvantages of marginal costing?
Does not comply with financial reporting standards, requires splitting of costs into fixed and variable parts, and ignores fixed costs
What are the advantages of full cost plus pricing?
Profit will be made if sales are met, mark up % can be adjusted
What are the disadvantages of full cost plus pricing?
Insufficient focus on market/competition, and may overprice for one off contracts
What are the advantages of marginal cost plus pricing?
Simple, useful when many items are sold, mark up % can be adjusted
What are the disadvantages of marginal cost plus pricing?
Insufficient focus on market conditions/competition, ignores fixed costs that must be covered in the long run
