Week 2 Everything

Question 1

the 2 cost accumulation systems

Answer 1

Marginal costing systems: Assigns only direct manufacturing costs to cost objects.

Absorption costing systems: Assigns both direct and indirect manufacturing costs to cost objects. Traditional costing system

Question 2

Under the absorption costing method:

Answer 2

All manufacturing costs (material, labour, variable and fixed overheads) are allocated to products. Non-manufacturing costs are NOT allocated to the products, but charged directly to the income statement. So, under this method, stocks are valued at their total (fixed and variable) manufacturing cost.

Question 3

Under the marginal costing method:

Answer 3

Only variable manufacturing costs (material, labour and variable overheads) are allocated to products, but fixed manufacturing costs are treated as period costs. Non-manufacturing costs are NOT allocated to the products, but charged directly to the income statement. So, under this method, stocks are valued on variable manufacturing costs.

Question 4

Absorption costing

Answer 4

Traces all manufacturing costs to products. Treats non-manufacturing overheads as a period cost.

Question 5

Marginal costing

Answer 5

Traces variable manufacturing costs to products. Treats fixed manufacturing overheads and non-manufacturing overheads as a period cost.

Question 6

Absorption and marginal costing: Similarities

Answer 6

Similar in terms of treating non-manufacturing costs Both marginal and absorption costing treat non-manufacturing costs as period costs.

Question 7

Absorption and marginal costing: Differences

Answer 7

Differ in terms of treating fixed manufacturing overhead costs.
Absorption costing includes fixed manufacturing costs to product cost and to inventory valuation. Marginal costing does not include fixed manufacturing costs to product costs and treat them as period costs.

Question 8

Marginal Vs absorption costing diagram

Answer 8

14/3/19

Question 9

Relevance of costs for short-term decision making: variable costs

Answer 9

Only variable costs are generally regarded as being relevant for short-term decision making, because they will be affected by a decision.

Question 10

Relevance of costs for short-term decision making: fixed costs

Answer 10

Fixed overhead costs are generally regarded as irrelevant for short term decision making, because they will not be affected by a decision.

Question 11

Fixed overhead costs are generally regarded as irrelevant for short term decision making, because they will not be affected by a decision.

Fixed costs:

Answer 11

Have been incurred or committed prior to a decision point and cannot be avoided (e.g., Sunk costs).

Are NOT considered to be the real costs of production.

Are considered as costs which provide facilities that enable production to take place.

Question 12

Using absorption costing for short-term decision making

Answer 12

As both variable and fixed manufacturing costs are absorbed into products, absorption costing shows the full cost of a unit of product. However, absorption costing is generally not helpful in (short-term) decision making, because it uses information on past fixed overhead costs.

Question 13

Using marginal costing for short-term decision making

Answer 13

Under marginal costing, fixed overhead costs are regarded as period costs and not part of the product costs. Therefore Product costs only include relevant costs (variable costs) that change by a decision. Product costs do not include irrelevant costs that do not change by a decision.

Question 14

Profit under absorption and marginal costing

Answer 14

Absorption and marginal costing give different profit figures when inventory levels are changing.

Question 15

Profit under absorption costing

Answer 15

In absorption costing, closing inventories include variable costs and their share of fixed costs. Share of fixed costs are carried forward to be treated as an expense of following periods, this is the main reason for the difference in profit figures.

Question 16

Profit under marginal costing

Answer 16

In marginal costing, closing inventories include only variable costs. Whole fixed costs are written off as an expense of the current year, reported profit is not affected by the changes in inventory levels.

Question 17

The main difference between variable costing and absorption costing is the way in which fixed manufacturing costs are accounted for:

Answer 17

Under variable costing, fixed manufacturing costs are treated as an expense of the period

Under absorption costing, fixed manufacturing costs are inventoriable costs. In our example, the fixed manufacturing cost is $1.20 per metre ($60,000/50,000 metres) produced.

Question 18

Marginal vs Absorption costing: Effect of inventory changes on profit

Answer 18

14/3/19

Question 19

Usefulness of absorption costing

Answer 19

Absorption costing is the required inventory method for external reporting in most countries. Absorption costing information may prove useful for long run decisions (such as pricing and product mix) as both variable and fixed manufacturing costs are included in product costs.

Question 20

Weakness of absorption costing:

Under absorption costing system:

Answer 20

Profits can increase when sales volume declines.

Profits can decline when sales volume increases and costs remain unchanged.

Question 21

Profits can increase when sales volume declines.

Profits can decline when sales volume increases and costs remain unchanged.

Answer 21

This enables managers to increase operating profit in a specific period by increasing production even if there is no customer demand for the additional production! By doing so managers may get higher bonuses based on absorption costing profit numbers. Higher operating profit may also increase manager’s share-based compensation.

Question 22

Absorption costing and performance measures

Undesirable build-up of inventories

Answer 22

Managers may seek to manipulate income by producing too many units. Production beyond demand will increase the amount of inventory on hand.

Question 23

Production beyond demand will increase the amount of inventory on hand.

Answer 23

Resulting in more fixed costs being capitalised as inventory. Leaving a smaller amount of fixed costs to be expensed during the period.

Question 24

Resulting in more fixed costs being capitalised as inventory. Leaving a smaller amount of fixed costs to be expensed during the period.

Therefore

Answer 24

profit increases and so, potentially, does a manager’s bonus

Question 25

Undesirable build-up of inventories

A manager may:

Answer 25

Decide to manufacture products that absorb the highest amount of fixed costs, regardless of demand (‘cherry-picking’). Accept an order to increase production, even though another plant in the same firm is better suited to handle that order or defer maintenance.

Question 26

Absorption costing and performance measures

Proposals for revising performance evaluation

Answer 26

Focus on careful budgeting and inventory planning.

Incorporate a carrying charge for inventory.

Change the period used to evaluate performance.

Include non-financial as well as financial variables in the measures used to evaluate performance

Question 27

Advantages of marginal costing

Answer 27

Shows consistent profit figures despite changes in inventory levels. Avoids fixed overheads being capitalised in unsaleable stocks. In a period with increasing stocks (when sales volumes are declining, but output is sustained), marginal costing shows lower profits than absorption costing does. Thus, in such periods, marginal costing gives the early profit warning more rapidly than does absorption costing. Provides more useful info for short term decisions.

Question 28

How does marginal costing assist in short-term decision making?

Answer 28

Marginal costing is the basis for cost-volume-profit (CVP) analysis.

Using the contribution information, marginal costing can be used:

Question 29

Using the contribution information, marginal costing can be used:

Answer 29

To establish the number of units required to break-even or to make a given profit.

To analyse the margin of safety (how much can the existing level of sales fall before the business starts to make losses).

Whether to make or to buy goods and so on.

Question 30

The relation between marginal costing and CVP analysis

Answer 30

If the variable cost increases, then the . contribution per unit will decrease. This means that more items will have to be sold in order to reach the break-even point.

If it is possible to reduce costs, then the contribution per unit will increase. This means that the company will reach the break-even point at a lower level of activity and will then be earning profits at a faster rate.

Question 31

Arguments against marginal costing

Answer 31

In the long rune, prices must cover all costs.

Fixed production costs are incurred in order to make output, it is therefore ‘fair’ to charge all output with a share of these costs.

If a product is only charged with variable costs, it may be difficult to see whether or not it is profitable.

Product pricing may be difficult.

Question 32

Should we use absorption costing or marginal costing?

Answer 32

Financial reporting rules require that absorption costing is used for external reporting.But for internal reporting purposes, choice of method depends on the purpose of costing. Marginal costing is generally useful for performance evaluation and short-term decision making. Absorption costing is generally useful for longer-term decision making.