Absorption and Marginal Costing (LECTURE 5)

Question 1

ABSORPTION COSTING SYSTEM / FULL COSTING SYSTEM

Answer 1

A costing system that allocates all manufacturing costs, including fixed manufacturing costs, to products and values unsold stocks at their total cost of manufacture.

All manufacturing costs are absorbed, whether fixed or variable.

Question 2

BUDGETED ACTIVITY

Answer 2

The activity level based on the capacity utilisation required for the next budget period.

Question 3

DIRECT COSTING SYSTEM / VARIABLE COSTING SYSTEM / MARGINAL COSTING SYSTEM

Answer 3

A costing system that assigns only variable manufacturing costs, to products and includes them in the inventory valuation.

Treat fixed production overheads as TIME PERIOD COST.
Product cost is VARIABLE only.

Question 4

NORMAL ACTIVITY

Answer 4

A measure of capacity required to satisfy average customer demand over a longer term period after taking into account seasonal and cyclical fluctuation.

Question 5

PERIOD COST ADJUSTMENT

Answer 5

The record of under- and over- recovery of fixed overheads at the end of a period.

Question 6

PRACTICAL CAPACITY

Answer 6

Theoretical capacity less activity lost arising from unavoidable interruptions.

Question 7

THEORETICAL MAXIMUM CAPACITY

Answer 7

A measure of maximum operating capacity based on 100% efficiency with no interruptions for maintenance or other factors.

Question 8

VOLUME VARIANCE

Answer 8

Another term used to refer to the under- or over- recovery of fixed overheads arising from actual activity being different from the activity level used to calculate the fixed overhead rate.

Question 9

CONTRIBUTION

Answer 9

The difference between sales revenue and variable costs (not just variable O/Hs).

There is no profit unless contribution exceeds fixed costs.

Question 10

Marginal costing statement headings.

Answer 10

Period
Sales
Opening Inventory
Production Cost
Less Closing Inventory
Marginal COS
CONTRIBUTION
LESS:
Fixed Production Cost
Non-manufacturing FC
NET PROFIT

Question 11

Absorption Costing Statement Headings.

Answer 11

Period
Sales
Opening Inventory
Production Cost
Less Closing Inventory
(Over)/Under Recovery
Recovery MFC
Cost of Sales
Non Manufacturing FC
Net Profit

Question 12

Why does absorption costing give a bigger profit than marginal costing when more goods are made than sold?

Answer 12

Because manufacturing fixed overheads (MFO) which would otherwise be charged to production (in marginal costing) are carried forward to the period in which the goods are sold.

Question 13

Why does marginal costing give a bigger profit than absorption costing when sales exceed production?

Answer 13

Fixed costs which (in absorption costing) had bee absorbed in products are now charged against profit.

Question 14

Advantages of marginal costing.

Answer 14

• Much closer link between sales and profits. Effect of inventory changes is removed from profit calculation.
• Provides much better information for decision making purposes for internal management purposes. This is because fixed costs are not tied up in unsold inventory.
• No issues of over/under recoveries; avoids the risk of capitalising MFO in unsold inventory.
• Forces management to carefully check sales volumes, sales prices, and costs of manufacture.

Question 15

Advantages of Absorption Costing.

Answer 15

• Must use for external reporting.
• Absorption costing underlines the importance of fixed costs, which are essential to businesses.
• Where used internally, it avoids fictitious losses, which could adversely affect a manager’s appraisal.

Question 16

What does CVP attempt to explain?

Answer 16

1. Volumes
2. Revenues
3. Profits

Assumes fixed / variable relationships are identified and remain constant + a number of other assumptions.

Question 17

COST, VOLUME, PROFIT ANALYSIS

Answer 17

A powerful financial technique, which enables us to determine useful information about a product’s or a firm’s break even point, overall profit , and relative security of operation.

Question 18

Assumptions of CVP

Answer 18

• Single product or constant sales mix.
• Separation of fixed and variable costs possible, marginal costing approach essential.
• Short term only.
• “Relevant range”, in which sales, profit and cost are all linear functions of volume.
• All production is sold.
• All other variables remain constant.

Question 19

Describe graph of total cost against volume of activity.

Answer 19

Fixed cost is a straight line, total cost starts at y-axis at fixed cost level.
Difference between total cost and fixed cost in variable cost.

Question 20

PROFIT

Answer 20

= REVENUES - TOTAL COSTS

NP = Px (a + bx)

NP = Net Profit
P = Selling price per unit
x = Level of output sold
a = Fixed costs
b = Variable costs per unit

Question 21

CONTRIBUTION MARGIN

Answer 21

The difference between revenue and ALL variable costs.

Question 22

BREAK-EVEN POINT

Answer 22

The volume (quantity) or sales needed to achieve a no-profit, no-loss position.

Found by dividing total fixed costs by contribution per unit.

Question 23

MARGIN OF SAFETY

Answer 23

The extent to which the planned volume of output or sales lies above the break-even point.
Percentage difference.