Marginal costing and absorption costing

Question 1

What is the importance of accurate cost information?

Answer 1

Accurate cost information is important for decision making.

Question 2

What has led to better methods of cost allocation?

Answer 2

Many companies still use the same information for external reporting and internal decision making.

Question 3

What can happen if cost information is too simplistic?

Answer 3

Decision mistakes can be made, such as the use of blanket overhead rates.

Question 4

What is absorption costing?

Answer 4

A method of costing that assigns all or a proportion of production overhead costs to cost units by means of overhead absorption rates.

Question 5

How are product costs built using absorption costing?

Answer 5

Product costs are built up through allocation, apportionment, and absorption.

Question 6

What are traditional reasons for using absorption costing?

Answer 6

• Stock valuation,
• pricing decisions, and
• establishing profitability of products.

Question 7

What are the steps involved in allocating costs in a traditional costing system?

Answer 7

1. Assign all manufacturing overhead to cost centres.
2. Reallocate costs from service to production cost centres.
3. Compute separate overhead rates for each production cost centre.
4. Assign overheads to products or cost objects.

Question 8

What is job order costing?

Answer 8

Used where many different products are produced each period, typically in small batches called jobs.

Question 9

What is process costing?

Answer 9

Used where manufacturing involves making a single homogeneous product for long periods of time.

Question 10

What are the similarities in cost allocation between job order costing and process costing?

Answer 10

Costs of materials, labour, and overheads are added to determine unit costs.

Question 11

How are overheads charged in costing systems?

Answer 11

Overheads are normally charged on a predetermined basis, often based on labour hours.

Question 12

What is one strength and two weaknesses of predetermined overhead rates?

Answer 12

Strength:

• Avoids fluctuating unit prices throughout the year.

Weaknesses:

• Differences in absorbed costs if activity levels vary; stocks carry overhead costs from prior periods.

Question 13

What are arguments for absorption costing? (3)

Answer 13

• It considers all costs,
• is consistent with external reporting, and
• requires less recording effort.

Question 14

What are arguments against absorption costing?

Answer 14

It is outdated, may not suit modern manufacturing, and can lead to arbitrary apportionments affecting decisions.

Question 15

What is marginal costing?

Answer 15

An alternative costing method where only variable costs are charged as a cost of sale.

Question 16

What is marginal cost?

Answer 16

The part of one unit of product that would be avoided if that unit were not produced.

Question 17

What is contribution in marginal costing?

Answer 17

Contribution = sales value - variable costs.

Question 18

How can contribution be expressed?

Answer 18

In absolute terms or contribution per unit.

Question 19

What is a limiting factor in contribution?

Answer 19

Contribution is linked to a key factor to cover fixed overhead and profit.

Question 20

What are two uses of marginal costing?

Answer 20

To provide information for short-term planning and in routine cost accounting.

Question 21

What are five arguments for marginal costing?

Answer 21

1. Easy to understand.
2. No arbitrary apportionments.
3. No over/under absorption of overhead.
4. Fixed costs are time-based.
5. Accounts resemble actual cash flow.