P1 - Marginal, Absorption and ABC Costing Flashcards
What 5 things are costing used for?
- Inventory Valuation
- Profit Reporting
- Pricing
- Decision Making
- Cost management and transformation
What are 3 key elements of the CGMA cost transformation model?
- Cost-conscious culture (continuous improvement)
- Understanding cost drivers
- Managing risks associated with a cost conscious culture (loss of quality, customer complaints)
What is prime cost?
The sum of all direct costs (materials, labour, direct expenses)
What is a fixed cost?
One which does not change with the level of activity, so varies with time rather than production
What is a stepped fixed cost?
One which does not change up to a certain point of activity, but then increases, then remains stable again
What is a variable cost?
One which changes depending on the level of activity
What is the marginal cost of a product?
The sum of all the variable costs - the additional cost incurred if just one more unit is made
What is the full absorption cost of a product?
The sum of all the variable costs plus an apportionment for fixed overheads
What is the equation for contribution?
Revenue - variable cost
What are the 5 steps in allocating costs through absorption costing?
- Allocate direct costs to cost units
- Allocate indirect costs to cost centres
- Apportion common costs between cost centres
- Re-apportion service cost centres to production departments
- Absorb the overheads into the cost units using Overhead Absorption Rates
What is the equation for OAR?
Total budgeted production overheads / budgeted level of activity
What is over/under absorption?
When more / less overhead is absorbed than is actually incurred
What produces a higher inventory value, marginal or absorption costing?
Absorption costing
If inventory increases, which is higher - marginal or absorption profit?
Absorption Profit
What is the reconciling figure between marginal and absorption profit?
The change in inventory x OAR
What are the 3 key advantages of marginal costing?
- Better for decision making
- Fixed costs are period costs
- Profit depends upon sales activity (better for performance evaluation)
What are the 3 key disadvantages of marginal costing?
- Doesn’t comply with FRSs
- All costs must be split into fixed and variable parts
- Fixed costs are being incurred so cannot be ignored
Why does traditional absorption costing often need to be replaced by ABC in the modern environment?
Overheads make up a large proportion of production costs, so overall apportionment is not accurate enough as costs are not caused equally by all products. One product may subsidise another and result in poor decision making.
What is activity based costing?
An approach to the costing and monitoring of activities which involves tracing resource consumption and costing final outputs, associating cost drivers with cost pools and allocating costs based on consumption
What is a cost driver?
A factor influencing the level of cost e.g. number of purchase orders
What is a cost pool?
Grouping of costs relating to a particular activity
What is a hierarchy of activities?
A classification of activities by level of organisation - product level, batch level, product sustaining and facility sustaining
What are the 4 steps of an ABC system?
- Analyse overheads into cost pools
- Establish a cost driver for each pool
- Work out the OAR for each cost driver
- Use the OAR for each cost pool to absorb costs
What are the 3 types of cost driver?
- Duration
- Transaction (volume)
- Intensity (amount used)
Under traditional/modern environments, at which hierarchy level are most costs incurred?
And why has this changed?
Product level vs batch/product sustaining level
Customers demand products at short notice and want different versions of products
What are the 4 main advantages of ABC?
- Assess costs of individual activities based on use of resources
- Enables accurate costing of activities - better so than marginal costing
- Makes waste/non value add activities more visible
- Helps with future product planning
What are the 3 main disadvantages of ABC?
- Difficult to establish
- Time consuming
- Provides too much detail and obscures the bigger picture
