S1 - marginal and absorption Flashcards
what is marginal costing
only variable costs are charged as a cost of sale
Calculates contribution
Closing stocks of works in progress or finished goods are valued at variable production cost
Fixed costs charged to profit and loss account when incurred
Measure profit based on an analysis of total contribution
what is contribution
= sales revenue - marginal cost of sales
what is the use of marginal costing
information for short term planning and decision making
Cost calculation
Stock valuation
what are the arguments for marginal costing
easy to understand
No arbitrary apportionments of overhead
No over or under absorption
Fixed costs incurred on a time basis - write them off in the period as incurred
Accounts prepared using marginal costing closely resemble actual cash flow situation
what are the stages of absorption costing
allocation = cost items charged direct to a cost centre or cost unit
Apportionment = indirect costs spread fairly between cost centres. Service centre costs apportioned to product cost centres
Absorption = overhead costs allocated to production cost centres are added to unit, job or batch costs
what is overhead apportionment
Overhead apportionment - apportioning service department costs
direct method = service centre costs —> production departments
Step down method = service centre costs —> production departments and some service centres
Repeated distribution method = service centre costs —> production departments and service centres —> production departments
what is overhead absorption
estimate overhead for the coming period
Estimate activity for the period
Overhead absorption rate = estimated overhead / budgeted activity
Use overhead absorption rate to absorb overheads into cost units
what is over and under absorption
occurs because the predetermined overhead absorption rates are based on estimates
Over absorption (too much) = overheads charged > actual
Under absorption (too little) = overheads charged < actual
what is the use of absorption costing
stock valuation
Pricing decisions
Establishing profitability of products
what is job order and process costing
Allocating costs in a traditional costing system
Job order costing
many different products produced each period
Small batches
Process costing
manufacturing involves making a single homogenous product for long period of time
Costs accumulated by department rather than job
what are the arguments for absorption costing
considers the importance of all costs in producing a product
Consistent with external reporting purposes
Requires less recording effort
what are the arguments against absorption costing
old system
More suitable for less complex manufacturing environments - now highly technological
Wrong decisions may be made by managers as they assume all costs in unit price must be recovered without considering relevant costs and sunk costs
what is reconciling profits
difference in profits reported is due to the different inventory valuation methods used
Increased inventory levels = AC profit > MC profit
Decreased inventory levels = AC profit < MC profit
Profit difference = change in inventory levels x overhead absorption rate per unit
