Costing Flashcards
What can marginal costing also be called?
Contribution costing
What costing methods do we need to know?
Marginal costing
Adsorption costing
Activity based costing
Standard costing
What can adsorption costing also be called?
full costing
What situations can marginal costing be used in?
Evaluating special order decisions
deciding whether to make or buy-in a particular product or component
Deciding which products to produce
Deciding what to produce when resources are scarce
Deciding what price to charge
what is marginal costing?
The cost of raising output by one more unit
what is marginal cost usually the same as?
variable cost of production only including costs that vary with output level
What are examples of marginal costs?
Workers
expenses
Materials
(added together= prime cost)
Are fixed costs allocated to output level with marginal costing?
No
What will managers often consider in businesses which marginal cost?
consider the size of the contribution (difference between revenue received and variable cost for an output)
When will an order be worth accepting? (marginal costing)
if revenue received is greater then the variable cost providing the business has spare capacity
What will happen if a business is considering accepting an order when they dont have spare capacity?
Any attempt to increase the output will involve incurring extra fixed costs (buying new premises) -not worth accepting
How can marginal costing help evaluate special order decisions?
New customer comes along with different/one off order
If going to get positive contribution and nothing better to do then accept
How can marginal costing help to decide whether to make or buy in a product or component?
Compare cost of making/buying in
If cheaper to buy in then in most cases this is best
How can marginal costing affect which products to produce?
if one product has a high marginal cost and low contribution stop producing it to focus on other products
How can marginal costing help decide what to produce when resources are scarce?
Will want to prioritise product with greatest contribution
How can marginal costing affect what price to charge?
Knowing marginal costs gives flexibility with prices as dont have to cover fixed costs only marginal
Can enter a new market with more competitive prices
What is the layout of a marginal costing statement?
Sales (selling price x units)
Less: variable costs
- direct materials
- direct labour
- indirect costs
Total contribution
Less: fixed costs
Profit for the year
What is a special order?
an order of goods at below the usual list price
What is a special order?
an order of goods at below the usual list price
What are some important factors in the decision of accepting a special order?
contribution the order makes
Capacity
Current utilisation
Future orders
Retaining customer loyalty
Customer response
Why does capacity have to be considered when deciding on a special order?
company must ensure it has enough resources to complete the order
worker overtime, space in factory
will more profitable order be replaced
are they at full capacity
will fixed cost increase- how much ( extra workers or new machines)
Why does current utilisation have to be considered when deciding on a special order?
Special order may be accepted if have difficulty finding work
Better to keep staff, resources and machines occupied with smaller contributions than nothing at all
Why do future order have to be considered when deciding on a special order?
company might be prepared to accept a lower contribution in the hope the customer will make bigger more profitable orders in the future
Why does retaining customer loyalty have to be considered when deciding on a special order?
company might accept an order that only makes a small contribution as a means of retaining a regular customers loyalty
Why does customer response have to be considered when deciding on a special order?
if existing customers discovered that identical product were being sold at a lower price than they paid it could cause resentment
Might damage the image of the company and could cause a loss of sales in the future
How can marginal costing be used when a company produce a range of products?
marginal costing can be used to rank the products according to the size of their contribution
What is specialisation?
When a business goes from producing multiple products to just one
What are the assumption when a company specialises?
Time to produce one good may not be the same as producing same amount of units of multiple goods
Customers might not be willing to buy only one product (might have liked the easiness of being able to get multiple product from one place)
How can marginal costing be used when some resources in production be come scarce?
can be used to decide which option to take
What can scarce resources also be called?
Limiting factors or constraints
What are some examples of limiting factors?
Shortage of skilled labour
Shortage of raw materials/components
Limited number of machine hours available
A shortage of factory space
What can be created to split resources when they are scarce?
Contribution statement
What is the contribution sales ratio also known as?
Profit volume ratio
What is the formula for contribution to sales ratio?
Contribution/Selling price
What does the contribution to sales ratio show?
proportion of your selling price is contribution
Businesses ability to add value (sell products for more than cost of making them)
Compare desirability of producing products
How can the contribution sales ratio be used when you know fixed costs?
Revenue to break even
Breakeven
Revenue needed to generate a certain profit level
What is the formula for calculating revenue at break even? (contribution sales ratio)
Total fixed costs/ Contribution sales
What is the formula for calculating revenue needed to generate a certain profit? (contribution sales ratio)
(total fixed costs+ target profit)/ selling price
What is a cost centre?
a department, machine, person to whom costs can be associated
How does CIMA define a cost centre?
production or service location, function, activity or item of equipment whose costs may be attributed to cost units
What are cost centres usually defined by?
Type of business (garage: repairs, sales or parts)
What can costs centres help a business to do?
Control what is going on (compare week to week)
Look at performance between centres
Hold managers responsible (motivating if good, wrong= responsibility)
Decision making (gives more information)
What are profit centres?
an area that generates revenue
How do you allocate profit by department?
One department may contribute more to the profit of the business than another
Splitting the profit up into centres takes account of this
How do you allocate profit by product?
if produce more than 1 product may be possible to allocate profit according to how much product contributed to overall profit
How do you allocate profit by location?
if have more than one branch likely contribution to overall profit is different. Making each a profit centre accounts for this
How do you allocate profit by individual?
if particular individual in an organisation is directly accountable for particular area may be possible that they become a profit centre to allocate correct profit to activity
How do you allocate cost by department?
for example, marketing department has certain costs allocated directly to it as do all other areas of business
How do you allocate cost by product?
business can split costs according to how much each product incurred while being produced, marketed, distributed and sold
How do you allocate cost by location?
some branches from a company may incur more costs than others using cost centre accounts for this
How do you allocate cost by individual?
the area an individual is accountable for could incur different levels of costs to others. Using individual as cost centre allows for this
What are cost units?
A unit of production which absorbs the cost centres overhead costs
What are an example of costs units? (College)
In college it might be the students
What are service departments?
Likely to be a cost centre
Will have overheads allocated (transport or warehouse etc)
BUT- do not have cost units (as don’t make anything)
Cost has to be re-apportioned to other cost centres
What are direct costs?
Those costs that can clearly be attributed as part of product production
What are prime costs?
Total of all direct costs-
Direct materials+ Direct labour+ Direct expenses
What are indirect costs?
Cannot be identified easily with the product being produced
What does adsorption costing determine?
total costs of production
What must accountants include when calculating cost of cost centre operation?
direct and indirect costs
What is cost allocation?
when indirect costs or overheads that are wholly associated with a particular cost centre can also be charged ‘directly’ to that cost centre
What are some examples of cost allocation?
Wages of an assembly line supervisor
Depreciation on assembly line machine
What is cost allocation not always so simple/ what is apportionment?
Some costs relate to more than one cost centre and will therefore need to be split between different departments in some fair way
What is the layout of a cost statement?
Direct materials
+ direct labour
+ direct expenses
= prime cost
+ factory overheads
= PRODUCTION costs
+ selling & distribution costs
+ admin costs
+ finance costs
= TOTAL costs
Sales
- Total costs
= Net profit
What are the 4 main stages of absorption costing?
Allocation
Apportion
Reapportion
Absorb
Why will the profit be higher when using absorption costing for closing inventory?
because the cost of a unit will contain both variable and fixed costs (lower cost of sales higher gross profit)
What does absorption rate per unit refer to?
rate that overheads are charged to units
What are some differences between marginal and absorption costing?
M= cost of extra unit, recognises fixed costs doesn’t change with activity (wont split them), Focuses on fixed and variable costs, used for management decision making
A= total cost to produce each unit, split fixed costs between output, direct and indirect expenses, must be used for financial accounting
What is the allocation of direct costs step? (step 1- absorption costing)
Giving cost to cost centres they relate to
What is the Apportion shared overheads to production and service cost centres? (Step 2- absorption costing)
Dividing costs to the various centres when its not possible to allocate overheads directly between centres because the costs are shared
How is apportion done? (absorption costing)
Number of methods/ bases
No set guidelines
Basis should be equitable and fair (to relevant centres)
What will happen if overheads aren’t apportioned fairly?
the business might charge inappropriate prices to customers
What are some examples of overheads and their possible bases? (absorption costing)
Rent and rates= floor area of cost centre
Building insurance= book values of buildings in cost centres
Staff canteen= number of staff in each cost centre
Admin= direct labour hours in each cost centre
What is the re-apportion of services centre overheads to production cost centres? (step 3 of absorption costing )
When the overheads of service departments must be split across the produciton departments
What is the absorb alloated, apportioned and re-apportioned overheads to cost units? (step 4 of absroption costing)
overheads are charged to production cot centres absorbed into cost units
Overheads absorbed on budgeted figures
What is the rate of overheads are charged to cost units called?
overhead absorption rate (OAR)
What is the basic formula for OAR?
Total budgeted cost centre overheads/ Total planned work in the cost centre
What is the most common way OAR is measured?
Labour or machine hours
When would you use machine hour overhead absorption rate?
most suitable when produciotn is capital intensive (when machine hours are high relative to labour)
Most overheads are related to the cost of using the machinery (depreciation, power, insurance, maintinence and repairs)
What is the formula for rate per machine hour? (OAR)
total cost centre overheads/ number of machine hours
When would you use direct labour hour overhead abosrption rate? (OAR)
suitble when production is labour intensive (direct labour costs are higher relative to capital costs)
What is the formula for Direct labour hour overhead absorption rate? (OAR)
total cost centre overheads/ total direct labour hours
Why might over absorption be acceptable?
more costs have been recovered then actually incurred leading to higher profit
What disadvantage can arise from over absorption?
if the business has set the price it charges to customers on the basis of covering its cost of production it will have set price too high in a competitive market it might lose sales and thus revenue
When will overheads be over absorbed?
the actual levels of overheads is lower is lower than the predicted level
Activity level is higher than predicted, possibly because there have been fewer breakdown than expect
When are ooverheads said to be under absorbed?
is insufficient overheads are included in the cost of production
Why might under absorption occur?
Actual level of overheads is higher than the predicted level
Activity level is lower than predicted
What are the advantages of absorption costing?
Ensures costs fully recovered
confirms accouting standard IAS2 (used when valuing stocks in final accounts as absorption covers share of fixed costs)
Indicates total costs or products and services
Identifies a profitability of different products and services
What are the disadvantages of absorption costing?
Based budgeted figures so may be inaccurate, and may not reflect current or future costs or activity levels
complex, time-consuming and expensive to gather all necessary data
Orders may be lost to rivals who set prices on basis of marginal costing
Potentially misleading guide to profitability of product units
Arbitary attribution of fixed cost to product units
What are the advantages of marginal costing?
Simple to do (unlike absorption costing)
Under/ over absorption doesnt occur
Useful for decision making (help rank products where limiting factors, make or buy in, breakeven, speacil order pricing)
Contribution per unit useful for mangers (breakeven analysis)
No arbitary apportionment of costs
What are the disadvantages of marginal costing?
Not used by published accounts in UK
Not always easy to identify marginal cost of production
If business running at full capacity any increase in output may incur high level of fixed costs
May not recover its fixed costs and could make a loss
What major differnece is there between marginal and absorption costing?
the wasy stocks are valued
How are stocks valued in marginal costing?
valued at their marginal (variable) production costs
How are stocks valued in absorption costing?
closing stocks are valued at their full production cost
Why is activity based costing used?
Has been developed to apportion the overheads by focusing on the cause of the cost rather than its behaviour i.e. fixed or variable
Charges overheads to products using Cost Pools and Cost drivers
What is a Cost Pool?
the location of a group of related indirect costs
What are Cost Drivers?
Factors which cause costs of an activity and also cause these costs to change
What is attributing? (costing)
charging overheads to output
What are some examples of Cost Pools?
Purchasing
Maintenance
Materials handling
Material recipt
Production Planning
Machine programming
Quality control
Despatching
What are some examples of Cost Drivers?
Number of purchase orders
Number of maintenace hours
Quantity of material handled
Number of batches received
Number of production runs
Number of set-ups
Number of inspections
Number of despatches
What is the formula for cost rate per activity?
total cost of cost pool/ cost driver (number)
What is the flow diagram for activity based costing?
activity=cost pools=cost driver=cost rate
What is an examples of stores department? (service departments under absorption costing)
Activity= Receiving goods into stores
Cost pool= Cost of receiving goods into store
Cost driver= Number of deliveries into stores
Cost rate= cost of receiving goods/number of deliveries
What are some formulas for cost driver rate?
total cost of pool/ cost drivers (number)
Total purchasing costs/ number of purchases
What are the steps for applying activity based costing?
Overhead costs incurred by same activity grouped together in cost pools
Cost driver is then identified and rate for each cost is calculated
Rate for each cost is. charged to production based in use of activity
What are the benefits of ABC over marginal costing?
More accurate cost info as cost drivers used to identify acitivity causing cost to be incurred
More objective as able to identify overhead costs relating to different products
Focuses on overhead costs
Gives management a good understanding why costs are incurred and how altered by changed production
More accurate calculation of selling price as overheads analysed to product
What are the disadvantages of ABC?
Admin driven- lots of records needed
Difficult, time consuming system to set up
Difficult to identify cost driver (regular updates needed)
Difficult to deal with common costs (rent and rates)
