chapter 35

Question 1

variable cost

Answer 1

a cost which varies in direct proportion to changes in the level of output

Question 2

why can direct labour be considered to be a variable cost

Answer 2

if workers are paid a piece rate according to the amount they produce, then direct wages are proportionate to output and these are variable costs. if direct workers are paid a fixed or basic wage regardless of their output, all wages paid to direct labour will not be in relation to output, but we still treat them as being proportionate to production and thus deem them to be variable costs

Question 3

fixed costs

Answer 3

a cost that remains unchanged within a certain level of activity or output

Question 4

stepped costs

Answer 4

fixed costs that are only fixed within certain limits and will increase to a higher level when that limit is reached

Question 5

semi variable cost

Answer 5

a cost that contains an element of both variable and fixed cost within it

Question 6

marginal cost

Answer 6

the cost of making one extra unit of output

Question 7

what is marginal cost based on

Answer 7

it is based on the principle that an additional unit of production will result in an increase in the variable costs but not the fixed costs

Question 8

what is marginal cost of production

Answer 8

the total variable costs of productioin

Question 9

contribution

Answer 9

the amount of earnings remaining after all direct costs have been subtracted from revenue. it is the difference between the total revenue and total variable costs

Question 10

contribution per unit

Answer 10

the difference between the selling price and variable cost of a unit of output

Question 11

contribution per unit formula

Answer 11

selling price per unit - variable costs per unit

Question 12

marginal cost of sales

Answer 12

the variable costs of production and selling of one extra unit of output. when variable selling expenses are included in the marginal cost it becomes the marginal cost of sales

Question 13

how does marginal costing help

Answer 13

helps management to decide on pricing policy

Question 14

contribution to sales ratio (C/S ratio)

Answer 14

the proportion of sales revenue that contributes towards the fixed costs and profit of a business

Question 15

contribution to sales ratio formula

Answer 15

contribution/ revenue * 100

Question 16

break even point

Answer 16

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

Question 17

margin of safety

Answer 17

the difference between budgeted or actual output and the break- even quantity.

Question 18

how is break even point useful

Answer 18

It is particularly useful for managers to know the break-even point of a product when making decisions about pricing and production levels.

Question 19

break even formula

Answer 19

fixed costs/contribution per unit

Question 20

what does the break even formula calculate

Answer 20

calculates the number of units that must be produced and sold before the fixed costs are covered. At the break-even point, total contribution will equal total fixed costs

Question 21

margin of safety formula

Answer 21

sales quantity - break even formula

Question 22

how can knowing the margin of safety help

Answer 22

Knowing a business’s margin of safety can be useful to managers as it helps them to understand the amount by which output could fall short before the business risks making a loss.

Question 23

break even chart

Answer 23

a diagrammatic representation of the profit or loss to be expected from the sale of a product at various levels of activity.

Question 24

when does break even point occur

Answer 24

it occurs where the sale line cuts the total cost line and there is neither profit or loss

Question 25

profit volume chart

Answer 25

a type of break even chart that only shows the profit or loss at each level of output

Question 26

limitations of break even profits and profit/volume charts

Answer 26

thy assume the variable cost per unit is constant at all levels of output but this is not always true in practice

fixed costs do not always stay the same because some costs may be stepped costs that are only fixed within certain limits

Costs may be semi-variable and are not easily classified as fixed or variable. For break- even to work, the fixed and variable elements must be separated and added in with the appropriate fixed or variable figures.

They assume the selling price is constant at all levels of output. However, for some products more revenue may only be achieved if customers are given discounts from the selling price.

A break-even or profit/volume chart can only be applied to one product at a time.

A chart can be time consuming to prepare.

The charts may mislead people whose accounting knowledge is limited, but trained accountants will know when to make allowances for the charts’ limitations

Question 27

target profit and marginal costing

Answer 27

If the managers of a business have an amount of profit that they are aiming to achieve, then marginal costing can be used to calculate the sales quantity needed to achieve this level of profit.

Question 28

target profit calculator

Answer 28

fixed costs + target profit/contribution per unit

Question 29

positive contribution

Answer 29

the contribution is above zero

Question 30

when are special orders considered

Answer 30

There are occasions when an individual order may be accepted below the normal selling price. This may be considered when there is spare capacity in the factory and other orders are not affected.

Question 31

positive contribution and special orders

Answer 31

for special orders, the general rule is that the selling price must exceed the marginal cost of production. This will allow the additional order to make a positive contribution towards the fixed costs and profit of the business

Question 32

why are special orders useful at below the usual selling price

Answer 32

to maintain production and avoid redundancy among a skilled workforce during period of poor trading

to promote a new product

to dispose of inventory that is slow-moving or no longer useful.

Question 33

how does marginal costing affect make or buy decisions

Answer 33

A manufacturer may find that it’s more profitable to buy goods from another supplier than make the goods itself. This involves a ‘make or buy’ decision. It may be relevant for goods that are already being produced, or to the introduction of a new product. The decision will be based mainly on whether the cost of buying the goods from another supplier is more or less than the marginal cost of production.

Question 34

how to use marginal costing to decide whether to make or buy

Answer 34

If the marginal cost of production is above the price quoted by the supplier then buy from the supplier.

If the marginal cost of production is below the price quoted by the supplier then make the good.

Question 35

limiting factor

Answer 35

anything that limits the quantity of goods that a business may produce

Question 36

scarce resource

Answer 36

a resource or material that has limited availability

Question 37

how is marginal costing used to make the best of limited resources

Answer 37

When there is a limited resource, a business making several different products should use the limited resources in a way that produces the most profit. when making the best use of limited resources, the products must be ranked according to the amount of contribution they make from each unit of the scarce resource. Production will then be planned to ensure that the scarce resource is concentrated on the highest- ranking products.

Question 38

why does marginal costing an absorption costing show two different profits

Answer 38

the two methods of costing: marginal and absorption, will produce different profits, as the closing inventory is valued in two different ways

Question 39

how do customer affect the final decisions of price

Answer 39

a large or important customer might put pressure on a business to provide goods at special (lower) prices. despite being unprofitable, a business may agree to this in the short term, in the hope or expectation that the customer will make future purchases at a higher price

Question 40

how do human resources affect the final decisions of price

Answer 40

a business may decide to priorities avoiding staff redundancies. this encourages mangers to accept special orders at low prices or to avoid closing a business unit unless staff can be redeployed to other parts of the business

Question 41

how do suppliers affect the final decisions of price

Answer 41

if a business has a strong or long standing relationship with a supplier then it might prefer not to make a shift from buying to making a product despite a possible financial gain

Question 42

benefits of marginal costing

Answer 42

Fixed costs are not included in the cost of production and therefore there is no arbitrary apportionment of fixed costs.

Contribution provides a reliable measure for short-term decision making.

Marginal costing clearly shows the impact on profit of fluctuations in the volume of sales. Under-absorption and over-absorption of overheads are not a problem as there is no need to calculate an overhead absorption rate.

The marginal costing technique can be used with standard costing

Question 43

limitations of marginal costing

Answer 43

Marginal costing is only useful for short-term decision making. Not all costs can easily be split into fixed costs and variable costs.

Under marginal costing, the fixed costs remain constant and variable costs vary according to the level of output. In reality, the fixed costs do not remain constant and the variable costs do not vary according to the level of output. In the long run, all costs are variable.

Inventory should not be valued using marginal costing for a financial reporting because fixed manufacturing overheads are required by IAS 2.

Marginal costing may encourage selling prices that are too low because fixed costs are not considered; however, fixed costs must be covered in the long term.

Marginal costing is most useful for a business that makes. a single product. A company making several products will have difficulty allocating fixed costs to each product with any degree of accuracy. This will make it difficult to calculate the break-even point for either a single product or the business as a whole.