Uses of Marginal Costing (LECTURE 6)

Question 1

CONTRIBUTION SALES RATIO

Answer 1

Provide an immediate view of a product’s desirability.

Question 2

How to make deletion decisions?

Answer 2

When considering to close down a factory/shop/branch, etc, or delete a product, decisions should be taken on a marginal costing basis alone.

Therefore all non-specific fixed overheads should be removed from the figures being used to make the decision.

Question 3

QUALITATIVE ISSUES RESULTING FROM DELETION DECISIONS?

Answer 3

Possibility of poor publicity, the loss of intellectual capital, the chance for a competitor to exploit the situation

Question 4

Relevant costing principles.

Answer 4

Use of relevant costing principles - to deal with special selling price decisions.

Certain items won’t be relevant:
Depreciation
General provisions
Anything which doesn’t change as a result of the decision.
Sunk costs always be irrelevant.
Opportunity costs/gains? always relevant.

Question 5

Why is net book value of equipment irrelevant for making decisions on its replacement?

Answer 5

Fixed costs can be relevant where they change between alternatives. Committed fixed costs don’t change - some discretionary ones will change.

Question 6

DIFFERENTIAL COSTING

Answer 6

It uses marginal costing techniques, and relies on spotting differences between the normal activity, and the activity which would take place if the opportunity was taken up.

Question 7

What happens when there is a limiting factor to production?

Answer 7

On occasion there may be limitations on the company to make or sell as many units as it would wish if there were no internal constraints or exogenous factors impacting on the production/sales programme.

In such circumstances we would convert the contribution margin per unit to contribution margin per scarce resource.

Question 8

LIMITING FACTOR EXAMPLE:

Product A:
Sales (units): 4,000
Selling price per unit: £30
VC of production for each unit: £18
Hours to make each product unit: 3 hours
Hours required to satisfy sales: 12,000

Product B:
Sales (units): 6,000
Selling price per unit: £22
VC of production for each unit: £11
Hours to make each product unit+ 2 hours
Hours required to satisfy sales: 12,000

Product C: 
Sales (units): 5,000
Selling price per unit: £15
VC of production for each unit: £10
Hours to make each product unit: 1 hour
Hours required to satisfy sales: 5,000

Answer 8

Product A:
Selling price per unit: £30
VC of production per unit: £18
Contribution margin per unit: £12
RANKING: 1
Contribution margin per scarce resource (hours): £4
RANKING: 3

Product B:
Selling price per unit: £22
VC of production per unit: £11
Contribution margin per unit: £11
RANKING: 2
Contribution margin per scarce resource (hours): £5.50
RANKING: 1

Product C:
Selling price per unit: £15
VC of production per unit: £10
Contribution margin per unit: £5
RANKING: 3
Contribution margin per scarce resource (hours): £5
RANKING: 2

Total hours available: 24,500

1. Make Product B:
   6,000 units at 2 hours per unit use: 12,000
   LEAVING AVAILABLE: 12,500
2. Make Product C:
   5,000 units at 1 hour per unit, use: 5,000
   LEAVING AVAILABLE: 7,500
3. Make Product A:
   2,500 units at 3 hours per unit: 7,500