Traditional Costing Flashcards
What is absorption costing?
Absorption costing determines the full production cost per unit.
It includes direct materials , direct labour, variable overheads and fixed production overheads
To work out fix production overheads per unit you need to work out the overhead absorption rate which is budgeted overhead cost divided by budgeted quantity
As overhead absorption rate is calculated at the beginning of the period and based on budgeted figures this can lead her and over or under absorption of overheads
Calculating OAR and basis
Overhead absorption rate is calculated as budgeted overhead cost divided by budgeted quantity of absorption base
Three types of absorption basis
- Units produced which is a simplest method when all costs units are identical
-machine hour rate which is most appropriate when there is mainly machine activity
- Labour hour right which is most appropriate in labour intensive cost centres
As advantages and disadvantages of absorption costing
Pros
- This method is required for financial reporting purposes
- fixed production costs can be a significant part of total cost
- over or under absorption can identify inefficient utilisation
Cons
- more complex and marginal cost
- based on predictions so can be under or over absorbed
-Encourages overproduction
What is marginal costing?
Marginal costing does not include fixed production costs
It is made up of direct materials direct direct labour and variable overheads
Contribution is a concept that lies at the heart of marginal costing and is calculated by sales price mile minus variable costs
Contribution is then used to pay for fix costs, which anything left leaves profit
Advanced years and disadvantages of marginal costing
Pros
- simple
- better for short-term decision-making
- Profits rise if cells rise
Cons
- Not allowed to use this for inventory IAS 2
- Fixed overhead may be significant
- Some direct costs may be fixed
