5 Marginal Costing and Pricing

Question 1

What is marginal costing?

Answer 1

Assigns only variable costs to cost units while FC’s are written off as period costs

Direct materials + Direct labour + Direct expenses = Prime Cost
+ Variable overheads = Variable production cost (marginal cost)

Question 2

What is a marginal cost?

Answer 2

This 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 unit were produced.

Question 3

What is contribution?

Answer 3

Sales value - variable cost of sales

Sales Revenue 
Less: Variable costs
 = Contribution 
Less Fixed Costs 
= Profit 

• if contribution > FC => profit made
• if contribution < FC => loss made
• if contribution = FC => break even

Question 4

What is the shortcut for working out the profit differences under marginal and absorption costing?

Answer 4

if inventory increases => absorption profit increase
If inventory decreases => absorption profit decrease

MOVEMENT IN INVENTORY (UNITS) X FIXED OAR

Question 5

What are the advantages and disadvantages of absorption and marginal costing?

Answer 5

Ads:

1. Better decision making
2. Fixed costs are treated as period costs (which is what they are)
3. Profit depends only upon sales

Disads:

1. Does not comply with financial reporting standards
2. All costs must be split into their fixed and variable parts
3. Fixed costs are being incurred and so cannot be ignored

Question 6

What are the advantages and disadvantages of full cost plus pricing?

Answer 6

Ads:

1. Profit will be made if budget sales are met
2. Useful where contract work is undertaken
3. Mark-up % can be adjusted

Disads:

1. Insufficient focus on market conditions and competition
2. May overprice for one off contracts

Question 7

What are ads and disads of marginal cost plus pricing?

Answer 7

Ads:

1. Simple (avoids absorbing fixed o/h’s)
2. Useful in retail situations where many items are sold
3. Mark-up % can be adjusted

Disads:

1. Insufficient focus on market conditions and competition
2. Ignores fixed costs that must be covered in the long run

Question 8

What are the ads and disads of marginal cost pricing?

Answer 8

Ads:
1. Useful as a min acceptable price for a one off piece of work or where there is spare capacity

Disads:
1. No use as a long-term strategy since FC’s must be covered to make a profit