Week 3

Question 1

What type of costing will we look at this week?

Answer 1

Variable costing or marginal costing

Question 2

What are the 2 ways manfuacturing firms calculate product cost?

Answer 2

Absorption costing and variable costing

Question 3

Out of marginal costing and Full costing, which is preffered by management accountants?

Answer 3

Marginal costing preffered for decision making and performance evaluation.

Question 4

Under full costing product costs was what?

Answer 4

Direct materials + Direct labour + Variable manfuacturing overheads + Fixed manfuacturing overheads.

Question 5

Under Marginal costing what is total product cost?

Answer 5

Direct labour + Direct materials + Variable manfuacturing overheads. Fixed manfuacturing overheads are treated as period costs, and written off against the total contribution.

Question 6

What is contribution?

Answer 6

total sales less total variable costs.

Question 7

What is contribution per unit?

Answer 7

selling price per unit less variable costs per unit.

Question 8

Why do we have marignal costing?

Answer 8

Modern thinking is that most costs are variable in the very long run and understand what they vary with. Management attention is concentrated on the more controllable measure of contribution. Full absorption costing not useful for decision making as it can be misleading.

Question 9

So again for marginal costing variable manfuacturing costs go where and fixed manfuacturing costs go where?

Answer 9

Variable manfuacturing costs are capitalised in closing inventory on SOFP and charged to I/S statement as Cost of goods sold.

Fixed manfuacturing costs are just expensed as period costs on I/S.

Question 10

How would the format of an income statement look for Marginal costing?

Answer 10

( less other variable costs means non manfuacturing variable costs).

Question 11

From flashcard 10 what was the income statement basically trying to say?

Answer 11

Revenue - variable cost of sales - other variable cost = total contribution for the business - fixed costs ( all manfuacturing fixed costs as well as non manfuacturing fixed costs) = profit or loss.

Question 12

So again for Absorption costing variable manfuacturing costs go where and fixed manfuacturing costs go where?

Answer 12

Question 13

Case: The SP company operates, amongst other things, a purpose-built production facility where it makes 40,000 motors per year to be used in the production of its sewing machines. The average cost per motor at this level of activity is:

Direct materials £5.50

Direct labour £5.60

Variable factory overhead £4.75

Fixed factory overhead £4.45

In January 2018, an outside supplier offers to supply a comparable motor to SP Company for £18 (incl. delivery). The price will be guaranteed for one year if SP company signs the contract by 28th February with delivery of the product starting soon after. Should SP (1) Make or (2) buy the motors?

Answer 13

Question 14

What motivations could management have on deciding between different costing approaches (over-costing vs. under-costing)? TBA

Question 15

When are Actual overhead absroption rated and Budgeted overhead absorption rates given during the year?

Answer 15

Actual overhead absorption rates

Not available before the end of the period

Budgeted overhead absorption rates

– Estimated before the start of the period

– Used in planning and budgeting

– Basis for comparison with actual cost

Question 16

What is the formula for Budgeted OAR again?

Answer 16

Budgeted Production overhead / Budgeted Activity level

Question 17

Answer 17

Total overhead absorbed = OAR x Actual activity

Question 18

What is the aim of Marignal costing?

Answer 18

The aim is to reach a figure called contribution, so in traditional income statement you have revenue - cost of sales = gross profit - expenses to get operating profit. Under marginal costing we want to sepatate the fixed cost from variable cost.

Question 19

Note that if closing inventory is greater than opening inventory what will give a higher profit absorption costing or marginal costing?

Answer 19

Absorption costing will give a higher profit this is because this means a lower cost of sales ( cos is opening inventory + Cost of goods manfuactured/purchases) - minus inventory) meaning higher gross profit.

Question 20

Note that if closing inventory is less than opening inventory what will give a higher profit absorption costing or marginal costing?

Answer 20

Marignal costing will give a higher profit because this would mean higher cost of sales(as cost of sales is opening inventory + costs of goods manfuactured/purchases - closing inventory), this would mean low gross profit.

Question 21

Prepare Income statement for year 2016 for marginal costing

Answer 21

Question 22

Prepare Income statement for year 2017 for marginal costing

Answer 22

Opening inventory is closing inventory from last year

Question 23

Before we do an absorption costing income statement must state the things that need to be included on I/S

Answer 23

Sales

Less Cost of sales

=Gross profit at standard

(add or minus) Work out Production volume variance (PVV)

= Real gross profit

Less non mancutaring costs

Operating profit.

Question 24

What is Production volume variance?

Answer 24

It tells us whether actual production is above or below predictied/budgeted volume.(Actual volume - Budgeted volume) x Fixed overhead rate

Question 25

For this example what is the fixed overhead rate charged per unit and what is the total cost per unit of goods manfuactured?

Answer 25

Fixed manfuacturing cost / budgeted production volume

so that is £100/100 = £1 per unit

remember variable manfucaturing cost per unit is £3 so add and 1

= 4 is what you times by actual production to find cost of goods manfuactured

Question 26

What is the PVV for both years under absorption costing and what letters do we use to denote this?

Answer 26

2016 = (120-100) x £1 = £20 this means you have charged more so you add to gross profit ( we denote as F)

2017 = (90-100) x £1 = (£10) this means you have charged less than actual cost per unit so you add to real gross profit ( we denote as U)

Question 27

Prepare an income statement for 2016 under absorption costing and what does this mean about manfuacturing costs?

Answer 27

It should have been 460 not 480

Question 28

Prepare an income statement for 2017 under absorption costing and what does this mean about manfuacturing costs?

Answer 28

Manfuacturing costs should be 370 not 360

Question 29

If budgeted volume > actual volume this means what?

Answer 29

PVV is unfavourable, subtract from Gross profit at standard to give lower gross profit. ( too little fixed cost has been absorbed)

Question 30

If budgeted volume < actual volume this means what?

Answer 30

PVV is favourable it is added to the gross profit at standard to give a higher actual gross profit ( too much fixed cost been abosrbed)

Question 31

Compare the differences in profit.

Question 32

Marginal V Full costing In a period, opening inventories were 825 units and closing inventories were 1,800 units. The profit based on marginal costing was £50,400 and profit using absorption costing was £60,150. What is the fixed overhead absorption rate per unit?

Answer 32

Question 33

AV LTD: Which one produces higher profit and by how much? (Absorption costing OR Marginal costing?)

• Selling price per unit £124
• Variable production costs per unit £54
• Fixed production costs per unit £36
• Other variable costs per unit £12
• Sales Volume 12,500 units
• Production volume 13,250 units
• Opening stock of finished items 980 units

Answer 33

First of all you work out which of the the closing inventory and compare to opening inventory and you see closing inventory is higher than opening inventory so aborsption costing would be higher

Opening 980 units

Production 13,250 units

Sold (12,500 units)

Hence Closing inventory 1,730 units

Increase in units from opening to closing = 750

Fixed production cost = £36 per unit

Absorption costing would show £27,000 higher profit than marginal (variable) costing (750 units x £36)

Question 34

So what are the undesirable effects of full costing?

Answer 34

Full costing enables a manager to increase operating profit in a specific period by increasing the production schedule. (Real Activities earnings management)

Undesirable stock building (high closing inventory i.e. high absorption of fixed costs in the closing inventory) –

Question 35

What are ways of alleviating the undesirable effects of full absorption method?

Answer 35

Companies can predict market demand more accurately by adopting technology.

Move towards “Just-in-Time” management to avoid stock piling

The transaction records are stored and accessible to everyone within the network.

Question 36

Does it matter which method you choose?

Answer 36

International accounting standards 2 (IAS 2) doesn’t allow Marginal costing for external reporting purposes.

Question 37

In the long run will the profits of marginal costing be the same as absroption costing?

Answer 37

They are the same. This is because all of the costs incurred will eventually be charged against sales; timing of the sales that causes the profit differences from period to period.

Question 38

What are some limitiations of marginal costing ?

Answer 38

It is difficult to classify exactly the expenses into fixed and variable category. Most of the expenses are neither totally variable nor wholly fixed..

Sales staff may mistake marginal cost for total cost and sell at a low price; which will result in loss or low profits.

Question 39

Lets try another example of Absorption costing method vs Marginal costing method

Prepare an income statement for the month ended January 20x7 for marginal costing

Answer 39

Question 40

Lets try another example of Absorption costing method vs Marginal costing method

Prepare an income statement for the month ended Febuary20x7 for marginal costing

Answer 40

Question 41

Before we work out income statement for absroption costing what is the fixed cost per unit for each product and what is total cost per unit of production

Answer 41

Fixed manfuacturing cost / budgeted output

40000/25000 = 1.6 + variable cost per unit = 3.6 for Jan

for febuary it is 44000/25000 = 1.76 + variable cost per unit = 3.96

Question 42

What is the PVV for January 20x7 and Febuary 20x7?

Answer 42

FEB PVV = (24000 - 25000) x 1.6 = (1600)

FEB PVV = (24000-25000) x 1.76 = (1760)

Question 43

Prepare an income statement for absroption costing for month ended January 20X7?

Answer 43

Question 44

Prepare an income statement for absroption costing for month ended Febuary 20X7?

Answer 44

Question 45

So how do we prove that for January absorption costing gives higher profit and by how much

Answer 45

January opening inventory is 0

Closing inventory is 3000

As you can see Absorption costing would give higher profits

By how much, you would have to do difference in inventory X fixed cost per unit = 3000 X 1.6 = 4800 and thats the profit difference.

Question 46

So how do we prove that for February Marginal costing gives higher profit and by how much?

Answer 46

Opening inventory is 3000

Closing inventory is 500

Opening inventory had a different Fixed cost per unit cost so 3000X1.6 = 4800

Also Closing inventory had a different Fixed cost per unit cost so 500 X 1.76 = 880

the difference in profit is 3920

Question 47

What is a differential cost and give an example?

Answer 47

is the change in the cost due to change in activity from one level to another

For example, if the cost of one alternative is £3,000 per year and the cost of another alternative is £5,000 per year. The difference of £2,000 would be differential cost.

Question 48

Is opportunity cost the same as Sunk cost?

Answer 48

NO sunk costs are expenditures that has been incurred and cannot be recovered even if a decision is abandoned. ( shown in SOFP as assets or expense

Question 49

What is a relevant costs and how do we decide between 2 options?

Answer 49

Those costs that will be affected by a decision may be referred to as relevant costs, while others are non-relevant and should be ignored in the analysis.

we choose the one with the lower total relevant cost

Question 50

Give examples of Non relevant costs?

Answer 50

Sunk or past costs

• Total Fixed overheads that will not increase or decrease ( ifi it OAR PER UNIT THAT WOULD BE RELEVANT AS COST CHANGES EACH UNIT BUT FIXED OVERHEAD NOT RELEVANT)

Question 51

Materials Y and Z will be used for the contract. 100 tonnes of material Y will be needed and sufficient material is in stock because the material is in common use in the company. The original cost of the material in stock is £1 per tonne but it would cost £1.20 per tonne to replace if it is used for this contract.

The material Z required is in stock as a result of previous over-purchasing. This material originally cost £500 but it has no other use. The material is toxic and if it is not used on this contract, then company must pay £280 to have it disposed of.

What is the relevant cost?

Answer 51

As material Y is used regularly, the replacement cost is the relevant cost

Material Z has a ‘negative’ cost if used for the contract. This is the saving that will be made through not having to pay the disposal cost of £280

Relevant cost = £120 (Y’s replacement cost 100x £1.20) - £280 (cost of disposal saved for Z)

Question 52

Give another example of non relevant costs?

Answer 52

Future expense for which an irreversible decision was taken in the past

Question 53

A garage buys a lorry for £10,000. It requires a new engine costing £2,500 that will take 20 hours to fit. The technicians will be paid £15 per hour to fit the engine. The technicians are short of work but the garage wishes to retain their services. The lorry could be sold immediately for £9,000.

What is the minimum price the garage should charge for the lorry after the engine has been fitted?

Answer 53

Opportunity cost of lorry 9,000

+Cost of new engine 2,500

=11,500

Question 54

A garage buys a lorry for £10,000. It requires a new engine costing £2,500 that will take 20 hours to fit. The technicians will be paid £15 per hour to fit the engine. The technicians are busy and are charged out at £50 per hour. The lorry could be sold immediately for £9,000. Relevant costs Exercise What is the minimum price the garage should charge for the lorry after the engine has been fitted?

Answer 54

Opportunity cost of lorry 9,000

+(20x50)Opportunity cost of technicians’ time 1,000

+Cost of new engine 2,500

=12,500

Question 55

The salary of a graduate researcher to oversee a new Product development. This new opening is for the new product. It is worth noting that salary will be a fixed cost of £26,000

Is this cost relevant?

Answer 55

26,000. Salary cost is entirely relevant. The term Fixed may have sounded as if it were non-relevant. It is a directly attributable fixed cost and therefore relevant.

Question 56

An extra monthly cost of £15,000 will be incurred to run a new machine for the Milton Keynes manufacturing plant of Hertfordshire Ltd. In addition, a new production order will reduce the fixed overhead absorbed per unit by £100 per month.

What is the relevant cost?

Answer 56

£15,000 extra cost of running the new machine is indeed relevant.

The saving due to a reduced overhead absorption rate is not relevant as there is no indication that the total overhead cost will be reduced in any way

Question 57

Here is an example of us trying to find the relevant cost to drive to france, out of which one is the relevant cost ?

Answer 57

A) Not relevant

B) Relevant

C)Not relevant

D) Relevant because it depends on usuage

E) Not relevant

F) Not relevant

Question 58

Here is an example of us trying to find the relevant cost to drive to france or take train, out of which one is the relevant cost ?

Answer 58

G) relevant cost

h) relevant

I) relevant cost ( non financial)

J) ( not relevant, as you have to do that anyway)

K) Relevant

L)Relevant

M) Relevant

N) Relevant

Question 59

Now what is the relevant financial cost of driving to france and taking train?

Answer 59

Question 60

Does relevant costs have to be financial?

Answer 60

Nope they can be Non-financial quantitative factors (e.g. time taken to vaccine everyone in the country)

Qualitative factors such as Employee morale

Question 61

If production volume increases from 8,000 to 10,000 units,

Select one:

A) total variable costs will increase by 25 per cent.

B) total variable costs will increase by 20 per cent.

C) mixed and variable costs will increase by 25 per cent.

D) total costs will increase by 20 per cent.

Answer 61

A

Question 62

The budgeted production for January was 1,000 units. It was expected that the total fixed manufacturing costs would be £2,000. The company actually produced 900 units. Under Absorption costing method, what would be the Production Volume Variance (PVV)?

Select one:

1) £100 unfavourable
2) £100 Favourable
3) £200 Unfavourable
4) £200 Favourable

Answer 62

We know for PVV when budgeted volume > actual volume it is unfavourable

so its either 1 or 3

so now we do

2000/1000 = £2 fixed manfuacturing cost per unit

PVV = ( 900-1000) X £2 = £-200

So answer is 3

Question 63

During the month of January, direct labour cost totalled £13,000 and direct labour cost was 40% of prime cost. If total production costs during the month were £70,000, the manufacturing overhead was:

Select one:

1) £37,500
2) £57,000
3) £22,500
4) £9,500

Answer 63

A

Question 64

Answer 64

The answer is £463000