Lecture 5 Flashcards
what is the difference between variable costing and absorption costing ?
Both variable costing and absorption costing treat non-production overheads as period expenses i.e. not included in the cost of products. However, they differ in their treatment of the production overheads.
what is absorption (full) costing?
all production (manufacturing) costs are absorbed into products
Product cost = Direct material
+
Direct labour
+
Variable mfg. overheads
+
Fixed mfg. overheads
(allocated to cost objects using blanket or department rates)
what are the Advantages of absorption costing ?
Absorption costing has a major advantage in that it meets the requirements of International Financial Reporting Standards.
IAS 2 (Inventories), paragraph 12 states: ‘the cost of conversion of inventories include costs directly related to the units of production, such as direct labour’
The requirements of IAS 2 imply that all external reporting must calculate production and inventory costs using absorption costing techniques
Since all production costs are incurred with a view to create a product for sale, all costs should attach to products until sold.
In the longer term, fixed production overhead costs must be recovered through sales if the business is to survive. Setting the stock value by reference to full costs encourages a pricing policy which covers full cost.
What is Variable (direct/marginal)costing?
Variable (direct/marginal)costing is when Only variable production (manufacturing) costs are included in product costs i.e. fixed costs are treated as a period cost.
Product cost = Direct material
+
Direct labour
+
Variable mfg. overheads
what are the Criticisms of Absorption Cost Systems?
Absorption costing produce misleading information
Misleading products costs occurs when an organization begins to drop products because full cost of the product is greater than its price
Absorption costing create incentives that are inconsistent with maximizing the value of the firm
what is Incentive to Overproduce in absorption costing?
Absorption Costing
Managers evaluated on the average cost per unit can improve their performance by just increasing the number of units produced
Producing more units may not help the organization if all the units cannot be sold
In the short-term, cost of goods sold is lower and net income is higher because some of the fixed costs are left in the ending inventory
whats the equation for contribution?
contribution = sales revenue - variabel costs
whats the equation for total contribution?
total contribution = total fixed costs + profit
Cost of goods sold (COGS) equatiion?
Cost of goods sold (COGS) = opening stock + bought - closing
