P1 - Marginal, Absorption and ABC Costing

Question 1

What 5 things are costing used for?

Answer 1

1. Inventory Valuation
2. Profit Reporting
3. Pricing
4. Decision Making
5. Cost management and transformation

Question 2

What are 3 key elements of the CGMA cost transformation model?

Answer 2

1. Cost-conscious culture (continuous improvement)
2. Understanding cost drivers
3. Managing risks associated with a cost conscious culture (loss of quality, customer complaints)

Question 3

What is prime cost?

Answer 3

The sum of all direct costs (materials, labour, direct expenses)

Question 4

What is a fixed cost?

Answer 4

One which does not change with the level of activity, so varies with time rather than production

Question 5

What is a stepped fixed cost?

Answer 5

One which does not change up to a certain point of activity, but then increases, then remains stable again

Question 6

What is a variable cost?

Answer 6

One which changes depending on the level of activity

Question 7

What is the marginal cost of a product?

Answer 7

The sum of all the variable costs - the additional cost incurred if just one more unit is made

Question 8

What is the full absorption cost of a product?

Answer 8

The sum of all the variable costs plus an apportionment for fixed overheads

Question 9

What is the equation for contribution?

Answer 9

Revenue - variable cost

Question 10

What are the 5 steps in allocating costs through absorption costing?

Answer 10

1. Allocate direct costs to cost units
2. Allocate indirect costs to cost centres
3. Apportion common costs between cost centres
4. Re-apportion service cost centres to production departments
5. Absorb the overheads into the cost units using Overhead Absorption Rates

Question 11

What is the equation for OAR?

Answer 11

Total budgeted production overheads / budgeted level of activity

Question 12

What is over/under absorption?

Answer 12

When more / less overhead is absorbed than is actually incurred

Question 13

What produces a higher inventory value, marginal or absorption costing?

Answer 13

Absorption costing

Question 14

If inventory increases, which is higher - marginal or absorption profit?

Answer 14

Absorption Profit

Question 15

What is the reconciling figure between marginal and absorption profit?

Answer 15

The change in inventory x OAR

Question 16

What are the 3 key advantages of marginal costing?

Answer 16

1. Better for decision making
2. Fixed costs are period costs
3. Profit depends upon sales activity (better for performance evaluation)

Question 17

What are the 3 key disadvantages of marginal costing?

Answer 17

1. Doesn’t comply with FRSs
2. All costs must be split into fixed and variable parts
3. Fixed costs are being incurred so cannot be ignored

Question 18

Why does traditional absorption costing often need to be replaced by ABC in the modern environment?

Answer 18

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.

Question 19

What is activity based costing?

Answer 19

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

Question 20

What is a cost driver?

Answer 20

A factor influencing the level of cost e.g. number of purchase orders

Question 21

What is a cost pool?

Answer 21

Grouping of costs relating to a particular activity

Question 22

What is a hierarchy of activities?

Answer 22

A classification of activities by level of organisation - product level, batch level, product sustaining and facility sustaining

Question 23

What are the 4 steps of an ABC system?

Answer 23

1. Analyse overheads into cost pools
2. Establish a cost driver for each pool
3. Work out the OAR for each cost driver
4. Use the OAR for each cost pool to absorb costs

Question 24

What are the 3 types of cost driver?

Answer 24

1. Duration
2. Transaction (volume)
3. Intensity (amount used)

Question 25

Under traditional/modern environments, at which hierarchy level are most costs incurred?

And why has this changed?

Answer 25

Product level vs batch/product sustaining level

Customers demand products at short notice and want different versions of products

Question 26

What are the 4 main advantages of ABC?

Answer 26

1. Assess costs of individual activities based on use of resources
2. Enables accurate costing of activities - better so than marginal costing
3. Makes waste/non value add activities more visible
4. Helps with future product planning

Question 27

What are the 3 main disadvantages of ABC?

Answer 27

1. Difficult to establish
2. Time consuming
3. Provides too much detail and obscures the bigger picture