Chapter 30 Marginal costing

Question 1

What is marginal cost?

Answer 1

It is the cost of making one extra unit. It is based on the principle that, an additional unit of production will only result in an increase in variable costs and that the fixed costs will not be affected. It is therefore the total variable costs of the production.

Question 2

What is contribution?

Answer 2

It is the difference between the selling price and the variable cost of a unit of output. It is also the difference between the total revenue and total variable costs.

It is also the addition of the fixed overheads + profit.

Question 3

How to calculate the contribution to sales ratio?

Answer 3

Contribution / Sales x 100

Question 4

What are the uses of the C/S ratio?

Answer 4

It can be used to calculate the total contribution when sales increase, by multiplying the new sales value by the C/S ratio percentage. This will give us the total contribution, which consists of the allowance made for fixed overheads and profit. Therefore we can calculate profit.

Question 5

How to calculate profit using contribution?

Answer 5

Calculate the total contribution, by multiplying the total output by the contribution per unit.

Profit = Contribution - Fixed overheads

Question 6

What is break even point?

Answer 6

It is the point at which the business makes neither profit nor loss. It is the point at which total fixed costs = total contribution.

Alternatively , when Total cost - Total variable costs = fixed costs.

Question 7

How to calculate break even?

Answer 7

Step 01 - Calculate the contribution per unit
Step 02 - To calculate break-even, Total fixed costs must be divided by contribution per unit. This will give us break-even in units.
Step 03 - To calculate break-even in revenue. Multiply the BEP in units by the selling price.

Alternatively
It can be calculated using the C/S ratio.
Step 01 -Divide contribution by the Sales. This will give us the c/s percentage.
Step 02 - Total fixed costs / contribution percentage obtained in step 01

Question 8

How to use the contribution formula to find how many units need to be sold to achieve a specific profit?

Answer 8

Step 01
Calculate total contribution
( Total fixed costs + required level of profit)
Step 02
Divide Total contribution / contribution per unit
This will give the number of units needed to be produced to achieve the said profit.

Question 9

What is a break-even chart?

Answer 9

It is a representation of the profit or loss expected from a sale of a product at various levels of activity.

Question 10

What are the limitations of break-even charts?

Answer 10

• If revenue and costs are represented y straight lines, they may be misleading. These elements are more accurately represented by curves, for instance, the selling price will be affected by discounts.
• Some costs may be semi-variable
• Many fixed costs are fixed only within a certain limit and may increase with the level of activity, such as stepped costs.
• the charts may mislead people whose accounting knowledge is limited, but trained accountants will know when to make allowances for the limitations of the chart.

Question 11

What is the marginal cost of sales?

Answer 11

When variable selling expenses are included in marginal cost, the result is the marginal cost of sales. It is the addition of the marginal cost and variable selling expenses.

Question 12

What is the principle a business must follow when making “ make or buy “ decisions ?

Answer 12

They must make sure that if the marginal cost of production is below the price quoted by the supplier, the offer must be rejected and vice versa.

Question 13

What does a business prioritize when making decisions about constrained resources?

Answer 13

The business must prioritise the product that gives the highest contribution margin per constraint resource.

Question 14

What are the advantages of marginal costing?

Answer 14

• It is easy to understand. Given that there are no fixed costs included and apportioned to the cost of production.
• Contribution provides a reliable measure for short term decision making.
• it shows clearly the impact on profit of fluctuations in the volume of output
• under absorption or over absorption is not a problem as there is no need to calculate OAR’s.
• it shows the relative contributions to profit that are made by each product.

Question 15

What are the disadvantages of marginal costing?

Answer 15

• marginal costing is only useful for short-term decision making
• Not all costs can be easily split into fixed and variable costs
• Under marginal costing, fixed costs remain constant and variable costs vary according to the level of output. In the long run, all costs are variable.
• In the case of loss by fire, if inventory is valued using marginal costing, the full amount cannot be recovered from the insurance company since no element of fixed overheads is included.
• It assumes that production methods will remain constant.