Week 1 - CVP, BEP, Relevant Costing, Marginal & Absorption Costing, Activity Based Costing Flashcards
Contribution Per Unit Formula
Price - Variable Costs per unit = Contribution per unit
Break Even Point
Volume BEP = Fixed Costs/Contribution per unit
CVP 3 Advantages & 2 Disadvantages
Advantages
Aids decision making
Allows managers to define the ideal selling price for each target level of profit
Simple and easy to understand
Disadvantages
Relies on a set of assumptions that:
- all other variables are constant
Linearity assumption
Costs can be accurately divided into fixed and variable
Only applies to a short-term horizon
Relevant Costing
The relevant costs and revenues required for decision-making are
only those that will be affected by the decision.
At its core, the concept of ‘opportunity cost
Focus only on:
- Relevant (differential) cash flows
- Ignore irrelevant costs such as sunk costs, common costs (e.g. apportioned overheads that aren’t DIRECT), committed costs, non-cash flows
Relevant Costing 3 Advantages, 2 Disadvantages
Advantages
More realistic than other
techniques (e.g., CVP)
§ Enables visibility of the net
cash impact of decisions
§ Considers exactly what will
change within the company as
a result of the decision
- e.g., opportunity costs
Disadvantages
Not easy for managers to calculate
Cannot always see the indirect
consequences of a decision:
– What about non-financial,
qualitative factors?
– Any reputation concern?
– Reliability of sub-contractors?
– Customers’ and Competitors’
reactions?
– Employees: Redundancy
concerns?
Absorption Costing vs Marginal Costing
Absorption is when you shared out fixed overheads into PRODUCT COSTS, apportioned
Marginal, or Variable Costing, is when you write costs off against overall pofit as PERIOD COSTS.
Just add the direct and variable costs per unit together to find unit product cost under MC
Fixed Overheads Absorption Rate
Budgeted Overheads/Budgeted Base (E.g.budgeted machine hours, labour hours etc.)
Under and Over Absorption
Budgeted FOAR is based on budgets, if the actual overheads differ we must change Cost of Sales
If actual OH are lower than absorbed, reduce CoS
and vice versa
I.e.
Find FOAR
FOAR x ACTUAL labour hours = new amount
Subtract the difference
MAKE SURE YOU DONT MULTIPLY THE NEW OVERHEADS BY THE NEW HOURS, instead you multiply the budgeted FOAR by the new base
Reconciling Income between Absorption and Marginal costing
(AC profit) - (MC profit) = (Fixed overheads in closing stock) - (fixed overheads in opening stock)
Overheads in … stock are FOAR x units in Closing/Opening Stock
IF INVENTORY LEVELS INCREASE, absorption costing gives the higher profit
IF INVENTORY LEVELS DECREASE, MC gives higher profit
Marginal Costing 4 Advantages and 3 Disadvantages
Advantages
Easiest approach to understand.
§ Variable costs are easily
identified; No need for estimates
§ Avoids issue of fixed overheads
being capitalised in stocks.
§ Helps short-term decision
making.
Disadvantages
§ It’s ‘Variable Costing’! (but, in
the long term, all costs are
variable).
§ May not cover all fixed costs,
if used for pricing decisions.
§ Cannot use Marginal Costing
for valuing inventory in the
Financial Statements
Total Absorption Costing 4 Advantages and 3 Disadvantages
Advantages
§ Recognises the importance of
Fixed Overheads
§ Theoretically superior – principle
of matching costs to revenue.
§ Consistency with external
requirements for Financial
Reporting.
§ Useful in Cost-Plus pricing
Disadvantages
Complex & time-consuming.
§ Lack of accuracy in modern
times.
§ Modern manufacturing is not
labour or machine hours
driven. Rather, it’s support-, process-, and technology driven.
A manager can artificially increase the amount of profit they’ve made in a year by raising inventory levels if using Absorption Costing. This is because more of the fixed costs have been absorbed by the inventory. As such, Fixed Costs in the units are carried forward tot he next period.
The process of Activity Based Costing
Calulcate the cost per unit using ABC OF EACH ACTIVITY. E.G.
Machine activitiy is £160,000. 8000 hours in total, so £160k/8k = £20 per machine hour
Step 2: Allocate the costs of activities to products based on their usage of an activity, finding total Overheads per Products
Step 3: Find overhead cost per unit produced. Add this to variable cost per unit to get total Cost per Unit
Activity Based Costing 3 Advantages & 4 Disadvanatages
Advantages
It recognises the complexity of
modern manufacturing.
§ It gives a good understanding
of what drives overhead costs (cause-and-effect allocation).
§ Helps decision
-making, e.g.:
* Product Pricing and Mix Decisions * Process Improvemen
Disadvantages
Costly to operate and difficult
to understand.
§ Sometimes cause
-effect
relationships are unclear.
§ “True” costs? Some degree
of arbitrary cost allocation still
present (e.g., cost driver).
§ Not all firms need ABC. § … A ’fashion’?
Preparing profit statements for Marginal Costing and TAC
Sales
Cost of Sales (Variable Costs)
Contribution (sales - CoS)
Budgeted Fixed costs
Over/Under absorption
Actual absorption
(REMEMBER IF OVER ABSORBED, REMOVE FROM CoS, under absorbed, add to CoS)
Non-manufacturing overheads
Profit
Calculating fixed overheads when activity levels affects the amount
Exercise lecture Week 1!
Work out what maximum capacity is from the question.
e.g. Production volume was budgeted at 1,008,000 cases - 70% of maximum capacity.
So 1,008,000 x/ 0.7 = 100% capacity
Divide this by 12 for each month (if question requires).
Then find the % of maximum capacity per month, and find the matching overheads for that value of activity.
See exercise Lecture week 1 for this!
