5 - Marginal costing and pricing decisions

Question 1

what is marginal costing

Answer 1

the variable cost of a product or services - cost avoided if unit wasn’t produced or provided

Question 2

what is contribution

Answer 2

selling price - all variable costs

any fixed costs deducted in total from contribution to give net profit

Question 3

what does the change in inventory correspond with in terms of profit levels

Answer 3

if inventory DECREASES, absorption costing will have a lower profit

if inventory INCREASES, absorption costing will have a higher profit

Question 4

difference in reported profit formula?

Answer 4

change in inventory volume x fixed production OH rate per unit

Question 5

advantages of marginal costing

Answer 5

• appropriate for decision making
• fixed costs treated in accordance with their nature
• profit depends on sales not production activity levels

Question 6

disadvantages of marginal costing

Answer 6

• doesn’t comply with IAS2
• costs must be analysed into fixed and variable parts
• fixed costs cannot be ignored in long run

Question 7

what is full cost plus pricing

Answer 7

an amount is added to the full cost base to represent the profit per unit a company wants to receive

+ % of profit

Question 8

what is marginal cost plus pricing

Answer 8

an amount of profit is added to the marginal cost only

Question 9

advantages and disadvantages of full cost plus pricing

Answer 9

ADVANTAGES:
- should ensure that fixed costs are covered

DISADVANTAGES:
- doesn’t take into account market and demand conditions

Question 10

advantages and disadvantages of marginal cost plus pricing

Answer 10

ADVANTAGES:
- simple and easy to use method
- draws attention to contribution and creates better awareness of concepts eg breakeven

DISADVANTAGES:
- pricing cant ignore fixed costs altogether - they must be covered in long run
- still doesn’t fully take into account market and demand

Question 11

profit using marginal costing method

Answer 11

1. contribution x no of units actually sold
2. less fixed costs
   = net profit

Question 12

profit using absorption costing principles

Answer 12

1. work out marginal cost profit
2. find the OAR per unit
3. work out opening and closing inventories
4. value these opening and closing inventories with the OAR per unit
5. • opening inventory
6. • closing inventory
7. work backwards to find this absorption cost figure

FORMULA:
absorption cost profit + fixed OH in opening inventory - fixed OH in closing inventory = marginal costing profit