Cost & Management Flashcards
Explain marginal costing
Extra cost of producing one additional item
Explain the term contribution
It is the amount each unit of sales revenue provides towards covering the cost of overheads
Explain break-even
The point where neither a profit nor a loss is made
What is the difference between marginal costing and absorption costing
Marginal costing:
Applies only those costs to inventory that were incurred when each individual unit was produced
Absorption costing:
Applies all production costs to all units produced
What are the limiting factors and its effect in marginal costing
- selling prices fixed on the basis of marginal cost will be useful only for short period of time
- short-term pricing based on contribution may lead to prices not covering total costs
- cost data may change suddenly, so decisions relying on contribution need to be reviewed and updated regularly
- may lead to overheads being regarded as relatively unimportant due to emphasis on variable costs
How is contribution made towards fixed costs & profit calculated?
Selling price
Less: variable cost (direct material + direct labour + direct expenses)
Contribution
Less fixed cost
Profit
How is break-even calculated?
Per unit:
Fixed cost divided by (selling price per unit - variable cost per unit)
In sales value:
Selling price x break-even point per units
Explain the term margin of safety
Not all businesses operate on full capacity. The margin of safety is the amount by which output can fall without producing a loss
Static: not moving/ changing
Businesses are rarely static, changes in cost & volume and revenue occur
How is contribution sales ratio calculated?
By subtracting variable cost of sales from the sales revenue and dividing that number by the sales revenue
SP pu - variable cost/ sales = answer in cents
SP pu - variable cost/ sales x 100 = answer in %
What are the advantages of break-even analysis?
- Graphical presentation easy to follow.
- Depicts relationships between Sales, Costs and Profit, and results of their interaction.
- Charts can be updated to Show effects of changes in variables.
- Emphasized profit aspect of business
- Assists management’s decision making.
- Most useful over limited output.
What are the disadvantages of break-even analysis?
- Charts need regular updating as variables changes.
• Difficult to identify data required if the business is multi- product.
• Volume of production assumed to be the only factor governing costs and revenue, and other factors ignored.
• Costs and revenue assumed to be linear.
• Not always possible to classify Costs as variable or fixed.
• Some maybe mixed only over a relatively short span of time and some variable costs do not necessarily increase in proportion to output.
Name & explain why marginal costing is used in decision making
•Pricing a product
- Price charged for product must cover all costs and also contain a profit margin. Businesses may simply fix prices on “cost-plus” (Production N$ 150 + 20 % profit = N$ 180) basis, but since “cost” can vary with level of activity it may be an unreliable price fixing measure. Marginal costing avoids uncertainty by focusing on the contribution made to fixed overheads.
- If for example competitor’s price is lower and company may also have to reduce price marginal costing may help the directors to decide. Whether they will choose to do so or not will depend on the following factors:
# Adequacy of a smaller profit margin
# Strength of customer loyalty to particular brand produced
# Overall demand of product
# Alternative use of resources if production of specific product is discontinued
# Possible cost-reduction measures.
• Accept or reject a special order
- It will sometimes happen that any spare productive capacity of a business can be used to contribute to its fixed overheads. A special order seeming at first unecono–mic can be worth accepting, providing marginal cost is met. If it covers marginal cost (Total VC) and also contributes towards fixed overheads it will benefit company to accept order.
• Make or buy a product
- Making components required yourself or buying parts from outside supplier. Various factors may influence decision to buy and marginal costing plays an important role.
• Continue or discontinue production
- Deciding to continue or close down a department.
Factors to be taken into account when closing down a department:
# Effect on sales in other departments
# Allocation of fixed assets
# Use of space
# Will suppliers lose faith in business
# How will staff be effected
# Effect on total expenses
