Marginal and Absorption Costing

Question 1

What is the classification by nature in cost accounting?

Answer 1

It determines whether costs are directly related to sales.

Question 2

Define direct costs.

Answer 2

Costs that can be directly attributed to each unit of production, including:
* Direct materials
* Direct labour
* Direct expenses

Question 3

What are indirect costs?

Answer 3

Costs that cannot be directly attributed to individual units produced but are necessary for business operations, including:
* Indirect materials
* Indirect labour
* Indirect expenses

Question 4

What is a prime cost?

Answer 4

The total of all direct costs, calculated as:
* Direct materials + Direct labour + Direct expenses

Question 5

What are production overheads?

Answer 5

The total of all indirect costs grouped together.

Question 6

How is total production cost calculated?

Answer 6

Total production cost = Prime cost + Production overheads.

Question 7

What are period costs?

Answer 7

Expenses that are attributed to accounting periods rather than specific products, such as:
* Advertising costs
* Administrative expenses
* Legal fees
* Research expenditure

Question 8

What are inventory costs?

Answer 8

Costs that can be attributed to products, including:
* Direct labour
* Direct materials
* Overhead costs incurred in production.

Question 9

What is absorption costing?

Answer 9

An accounting method used to determine the full production cost per unit, including both direct and indirect costs.

Question 10

What are the steps in overhead allocation for absorption costing?

Answer 10

1. Overhead allocation to cost centres
2. Apportioning general overheads
3. Re-apportionment of service cost centres
4. Apportioning overheads to cost unit production.

Question 11

What is the overhead absorption rate (OAR)?

Answer 11

OAR = Production overhead / Activity level.

Budgeted numbers

Question 12

What is the predetermined overhead absorption rate?

Answer 12

It is calculated using budgeted figures and is used for planning purposes.

Question 13

What is the formula for calculating total contribution in marginal costing?

Answer 13

Total contribution = Contribution per unit x total unit sales.

Question 14

True or False: Marginal costing includes fixed production costs in the cost of each unit.

Answer 14

False.

Question 15

Define marginal costing.

Answer 15

A costing method where fixed production costs are treated as period costs and not included in unit costs.

Question 16

What is the marginal cost formula?

Answer 16

Marginal cost = Direct materials + Direct labour + Variable overheads per unit.

Question 17

How is profit calculated under absorption costing?

Answer 17

Profit = Total sales - Cost of goods sold + Over/unnder absorption.

Question 18

What is over absorption?

Answer 18

When the overhead included in the accounts is more than the actual overhead incurred.

Question 19

What happens to fixed production overheads in marginal costing?

Answer 19

They are written off against profit at the end of the period.

Question 20

What is the difference in stock valuation between absorption costing and marginal costing?

Answer 20

Absorption costing includes fixed overheads in stock valuation, while marginal costing values stock at variable cost only.

Question 21

Fill in the blank: The total production cost per unit under absorption costing is calculated as _______.

Answer 21

[Fixed production cost per unit + Variable production cost per unit]

Question 22

What is the significance of calculating the over absorption rate?

Answer 22

It helps adjust profit calculations to reflect actual costs incurred.

Question 23

What is the impact of under absorption on profit calculations?

Answer 23

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.

Question 24

How is stock valued under a marginal costing system?

Answer 24

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.

Question 25

What is the difference in profit between absorption costing and marginal costing systems due to?

Answer 25

The difference is due to how each system values stock ## Footnote Absorption costing includes fixed overhead costs in inventory valuation, while marginal costing does not.

Question 26

What key adjustment must be made in the profit statement under absorption costing?

Answer 26

An adjustment for over/under absorption must be included ## Footnote Over absorption means deducting excess fixed costs from the full production cost.

Question 27

In marginal costing, what does an increase in sales volume do to profit?

Answer 27

Increases profit ## Footnote Profit increases with higher sales volumes and decreases with lower sales volumes.

Question 28

What are the advantages of absorption costing?

Answer 28

Advantages include: * Recognizes both fixed and variable overheads * Consistent with financial accounting standards * Fair allocation of costs using the matching principle ## Footnote This helps ensure that products are sold profitably.

Question 29

What is a disadvantage of absorption costing?

Answer 29

It can lead to profit manipulation by increasing production levels ## Footnote This can create a false sense of profitability due to fixed costs being carried forward.

Question 30

What is the main advantage of marginal costing?

Answer 30

It clearly illustrates contribution ## Footnote This allows management to focus on controlling costs that affect contribution.

Question 31

What is a key disadvantage of marginal costing?

Answer 31

It may give an illusion of profitability when fixed costs are not covered ## Footnote This can lead to loss-making operations despite showing a positive contribution.

Question 32

Fill in the blank: Under absorption costing, fixed overheads are only deducted from profit when the actual units are _______.

Answer 32

sold ## Footnote This allows for costs to be allocated fairly based on actual sales.

Question 33

How does an increase in closing stock affect profit under absorption costing?

Answer 33

It increases profit ## Footnote This is because fixed costs are not deducted in the current period but carried forward.

Question 34

How is the profit reconciliation between costing systems achieved?

Answer 34

By understanding changes in stock levels and absorption adjustments ## Footnote This helps clarify profit differences for management.

Question 35

What does IAS2 require for valuing inventory?

Answer 35

Absorption of fixed overhead costs ## Footnote IAS2 refers to the International Accounting Standard 2, which deals with inventories.

Question 36

What is throughput accounting?

Answer 36

Throughput accounting emphasizes profitability by optimizing the bottleneck in production. ## Footnote Throughput accounting emphasizes profitability by optimizing the bottleneck in production.

Question 37

What does the theory of constraints (TOC) state?

Answer 37

You can only produce products as fast as your slowest department allows ## Footnote The slowest department sets the pace for the entire operation.

Question 38

What is a bottleneck in production?

Answer 38

The slowest department or part of a process that limits overall production capacity ## Footnote Identifying and addressing bottlenecks is crucial for improving efficiency.

Question 39

What are the two types of actions in throughput accounting?

Answer 39

Short-term to optimize output of the bottleneck and long-term to remove the bottleneck ## Footnote This approach encourages continuous improvement in production processes.

Question 40

How does throughput accounting differ from marginal costing?

Answer 40

Throughput accounting considers only material costs as variable costs, treating all other costs as fixed ## Footnote In marginal costing, both direct labor and materials are considered variable costs.

Question 41

What is throughput contribution?

Answer 41

Sales revenue - material cost ## Footnote Throughput contribution focuses on the profit generated from sales after accounting for material costs.

Question 42

What is the primary focus of throughput accounting?

Answer 42

Maximizing the speed at which a business can generate throughput ## Footnote This involves increasing sales and reducing bottlenecks.

Question 43

True or False: In throughput accounting, producing excess stock is rewarded.

Answer 43

False ## Footnote Unlike absorption costing, throughput accounting does not reward excess stock production.

Question 44

What is the return per time period formula in throughput accounting?

Answer 44

Return per time period = (Sales revenue - material costs) / Time period ## Footnote This formula helps managers focus on maximizing throughput.

Question 45

What is the impact of bottlenecks on production?

Answer 45

Bottlenecks can lead to increased inventory and costs without generating additional revenue ## Footnote Managing bottlenecks is essential for maintaining efficient operations.

Question 46

What is the purpose of the throughput accounting ratio?

Answer 46

To measure the return from a product against the cost of running the factory ## Footnote A higher TA ratio indicates better profitability relative to costs.

Question 47

What factors can improve the TA ratio of a product?

Answer 47

Increasing throughput contribution, increasing return per factory hour, reducing cost per factory hour ## Footnote Each factor can positively influence the overall profitability of a product.

Question 48

What is the formula for calculating the TA ratio?

Answer 48

TA ratio = Return per factory hour / Cost per factory hour ## Footnote This ratio helps prioritize products based on profitability.

Question 49

Fill in the blank: Throughput accounting identifies costs as either __________.

Answer 49

material costs or fixed costs ## Footnote This distinction is important for understanding how costs are treated in throughput accounting.

Question 50

What should a manager focus on in a production environment with a bottleneck?

Answer 50

Maximizing the efficiency of the bottleneck while managing other departments at a speed they can keep up with ## Footnote This helps optimize overall production and minimize waste.

Question 51

What is the financial implication of a high TA ratio?

Answer 51

It indicates that a product generates more value per hour than it costs to produce ## Footnote A TA ratio above 1 is generally considered worthwhile.

Question 52

When to use throughput accounting?

Answer 52

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. ## Footnote This is because the reality of modern manufacturing is that direct labour and other overheads are in fact fixed in the short term.

Question 53

What are the steps to construct a profit statement under marginal costing?

Answer 53

1. Calculate cost per unit (sum of variable production costs per unit) 2. Compile profit statement - deduct all variable expenses from sales / deduct fixed costs to calculate profit

Question 54

What are the steps to contruct a profit statement under absorption costing?

Answer 54

1. Calculate cost per unit (divide fixed production overheads by budgeted unit capacity. Add this figure to total variable production costs) 2. calculate the level of under/over absorption ((OAR * production) - Budgeted Fixed overheads) 3. Compile profit statement

Question 55

What are you doing when you apply an adjustment because of an over / under absorption?

Answer 55

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

Question 56

Return per factory hour

Answer 56

Throughput contribution per unit / number of factory hours per unit

Question 57

Cost per factory hour

Answer 57

Total Factory Cost / Total Number of Factory Hours

Question 58

TPAR - Throughput Accounting Ratio

Answer 58

Return per factory hour / cost per factory hour ## Footnote Should be above 1