Marginal and Absorption Costing Flashcards
What is the classification by nature in cost accounting?
It determines whether costs are directly related to sales.
Define direct costs.
Costs that can be directly attributed to each unit of production, including:
* Direct materials
* Direct labour
* Direct expenses
What are indirect costs?
Costs that cannot be directly attributed to individual units produced but are necessary for business operations, including:
* Indirect materials
* Indirect labour
* Indirect expenses
What is a prime cost?
The total of all direct costs, calculated as:
* Direct materials + Direct labour + Direct expenses
What are production overheads?
The total of all indirect costs grouped together.
How is total production cost calculated?
Total production cost = Prime cost + Production overheads.
What are period costs?
Expenses that are attributed to accounting periods rather than specific products, such as:
* Advertising costs
* Administrative expenses
* Legal fees
* Research expenditure
What are inventory costs?
Costs that can be attributed to products, including:
* Direct labour
* Direct materials
* Overhead costs incurred in production.
What is absorption costing?
An accounting method used to determine the full production cost per unit, including both direct and indirect costs.
What are the steps in overhead allocation for absorption costing?
- Overhead allocation to cost centres
- Apportioning general overheads
- Re-apportionment of service cost centres
- Apportioning overheads to cost unit production.
What is the overhead absorption rate (OAR)?
OAR = Production overhead / Activity level.
Budgeted numbers
What is the predetermined overhead absorption rate?
It is calculated using budgeted figures and is used for planning purposes.
What is the formula for calculating total contribution in marginal costing?
Total contribution = Contribution per unit x total unit sales.
True or False: Marginal costing includes fixed production costs in the cost of each unit.
False.
Define marginal costing.
A costing method where fixed production costs are treated as period costs and not included in unit costs.
What is the marginal cost formula?
Marginal cost = Direct materials + Direct labour + Variable overheads per unit.
How is profit calculated under absorption costing?
Profit = Total sales - Cost of goods sold + Over/unnder absorption.
What is over absorption?
When the overhead included in the accounts is more than the actual overhead incurred.
What happens to fixed production overheads in marginal costing?
They are written off against profit at the end of the period.
What is the difference in stock valuation between absorption costing and marginal costing?
Absorption costing includes fixed overheads in stock valuation, while marginal costing values stock at variable cost only.
Fill in the blank: The total production cost per unit under absorption costing is calculated as _______.
[Fixed production cost per unit + Variable production cost per unit]
What is the significance of calculating the over absorption rate?
It helps adjust profit calculations to reflect actual costs incurred.
What is the impact of under absorption on profit calculations?
Under absorption increases profit as it adds to the costs for the next accounting period
This means the fixed costs that were not allocated to the current period’s inventory will be accounted for in the next period.
How is stock valued under a marginal costing system?
Stock is valued at variable cost only
This means fixed production overheads are treated as a period cost and are deducted in full from profit.
What is the difference in profit between absorption costing and marginal costing systems due to?
The difference is due to how each system values stock
Absorption costing includes fixed overhead costs in inventory valuation, while marginal costing does not.
What key adjustment must be made in the profit statement under absorption costing?
An adjustment for over/under absorption must be included
Over absorption means deducting excess fixed costs from the full production cost.
In marginal costing, what does an increase in sales volume do to profit?
Increases profit
Profit increases with higher sales volumes and decreases with lower sales volumes.
What are the advantages of absorption costing?
Advantages include:
* Recognizes both fixed and variable overheads
* Consistent with financial accounting standards
* Fair allocation of costs using the matching principle
This helps ensure that products are sold profitably.
What is a disadvantage of absorption costing?
It can lead to profit manipulation by increasing production levels
This can create a false sense of profitability due to fixed costs being carried forward.
What is the main advantage of marginal costing?
It clearly illustrates contribution
This allows management to focus on controlling costs that affect contribution.
What is a key disadvantage of marginal costing?
It may give an illusion of profitability when fixed costs are not covered
This can lead to loss-making operations despite showing a positive contribution.
Fill in the blank: Under absorption costing, fixed overheads are only deducted from profit when the actual units are _______.
sold
This allows for costs to be allocated fairly based on actual sales.
How does an increase in closing stock affect profit under absorption costing?
It increases profit
This is because fixed costs are not deducted in the current period but carried forward.
How is the profit reconciliation between costing systems achieved?
By understanding changes in stock levels and absorption adjustments
This helps clarify profit differences for management.
What does IAS2 require for valuing inventory?
Absorption of fixed overhead costs
IAS2 refers to the International Accounting Standard 2, which deals with inventories.
What is throughput accounting?
Throughput accounting emphasizes profitability by optimizing the bottleneck in production.
Throughput accounting emphasizes profitability by optimizing the bottleneck in production.
What does the theory of constraints (TOC) state?
You can only produce products as fast as your slowest department allows
The slowest department sets the pace for the entire operation.
What is a bottleneck in production?
The slowest department or part of a process that limits overall production capacity
Identifying and addressing bottlenecks is crucial for improving efficiency.
What are the two types of actions in throughput accounting?
Short-term to optimize output of the bottleneck and long-term to remove the bottleneck
This approach encourages continuous improvement in production processes.
How does throughput accounting differ from marginal costing?
Throughput accounting considers only material costs as variable costs, treating all other costs as fixed
In marginal costing, both direct labor and materials are considered variable costs.
What is throughput contribution?
Sales revenue - material cost
Throughput contribution focuses on the profit generated from sales after accounting for material costs.
What is the primary focus of throughput accounting?
Maximizing the speed at which a business can generate throughput
This involves increasing sales and reducing bottlenecks.
True or False: In throughput accounting, producing excess stock is rewarded.
False
Unlike absorption costing, throughput accounting does not reward excess stock production.
What is the return per time period formula in throughput accounting?
Return per time period = (Sales revenue - material costs) / Time period
This formula helps managers focus on maximizing throughput.
What is the impact of bottlenecks on production?
Bottlenecks can lead to increased inventory and costs without generating additional revenue
Managing bottlenecks is essential for maintaining efficient operations.
What is the purpose of the throughput accounting ratio?
To measure the return from a product against the cost of running the factory
A higher TA ratio indicates better profitability relative to costs.
What factors can improve the TA ratio of a product?
Increasing throughput contribution, increasing return per factory hour, reducing cost per factory hour
Each factor can positively influence the overall profitability of a product.
What is the formula for calculating the TA ratio?
TA ratio = Return per factory hour / Cost per factory hour
This ratio helps prioritize products based on profitability.
Fill in the blank: Throughput accounting identifies costs as either __________.
material costs or fixed costs
This distinction is important for understanding how costs are treated in throughput accounting.
What should a manager focus on in a production environment with a bottleneck?
Maximizing the efficiency of the bottleneck while managing other departments at a speed they can keep up with
This helps optimize overall production and minimize waste.
What is the financial implication of a high TA ratio?
It indicates that a product generates more value per hour than it costs to produce
A TA ratio above 1 is generally considered worthwhile.
When to use throughput accounting?
Short term; throughput accounting is best suited to a management team where overheads and labour will be paid at the end of the day or week irrespective of how many units are produced.
This is because the reality of modern manufacturing is that direct labour and other overheads are in fact fixed in the short term.
What are the steps to construct a profit statement under marginal costing?
- Calculate cost per unit (sum of variable production costs per unit)
- Compile profit statement - deduct all variable expenses from sales / deduct fixed costs to calculate profit
What are the steps to contruct a profit statement under absorption costing?
- Calculate cost per unit (divide fixed production overheads by budgeted unit capacity. Add this figure to total variable production costs)
- calculate the level of under/over absorption ((OAR * production) - Budgeted Fixed overheads)
- Compile profit statement
What are you doing when you apply an adjustment because of an over / under absorption?
Over - you have absorbed too much fixed costs - you need to DEDUCT from full production cost
Under - you have absorbeed too little fixed costs - you need to ADD to full production cost
Return per factory hour
Throughput contribution per unit / number of factory hours per unit
Cost per factory hour
Total Factory Cost / Total Number of Factory Hours
TPAR - Throughput Accounting Ratio
Return per factory hour / cost per factory hour
Should be above 1
