Marginal Costing Flashcards
(16 cards)
What is marginal costing
The cost of producing one extra unit of output
What type of costs does marginal costing not involve
Fixed costs
What is the structure of a marginal costing statement
Sales revenue
LESS variable costs
= contribution
LESS fixed costs
= PROFIT
How do you calculate a limiting factor question
- Determine the limiting factor
- Calculate the contribution per unit for each product made
- Calculate the contribution per unit of the limiting factor
- Rank the products
- Distribute the scarce resource in ranked order
- Calculate expected profit
What are direct and indirect costs
Direct costs:
Costs directly involved in the manufacture of goods e.g. raw materials
Indirect costs:
Overheads that cannot be identified directly with a specific unit of output e.g. insurance, factory rent
What are variable, semi-variable and fixed costs
Variable costs:
Costs that vary directly/ in proportion with output e.g. raw materials
Semi-variable costs:
Costs that have fixed and variable components e.g. telephone bill
Fixed costs:
Costs that remain constant regardless of the units of output e.g. rent
What are stepped costs
Costs that remain fixed within certain activity levels but increase in steps when thresholds are exceeded e.g. supervisors
(Costs which increase by a large amount all at once)
What is contribution
The sales minus the variable costs in a period is the total contribution that the sales make towards the fixed costs and profits of the business
Closure of potentially loss-making line or production department essay structure
INTRO
Sometimes a product line or production department can make a loss when the fixed costs, as well as the variable costs, have been apportioned to it.
The business needs to consider if it would be more profitable if it stopped making the product
MC can be used to compare the contribution made by a line or production department to the overall profitability of the business
The key point is that the fixed costs of the whole business may not decrease if that section is no longer operative because the fixed costs may have to be reapportioned to the other sections
MAIN POINTS
check that the basis of apportionment of fixed costs is appropriate to each line or production department
can the price of the loss-maker’s products be increased to make it profitable?
can sales of the loss-maker be increased (eg with marketing), costs reduced (eg cheaper buying prices of materials), or a more efficient production process used (eg more automation)?
If the loss-maker is to be closed, what will take its place? Perhaps the unused capacity can be diverted to another - more profitable - product. If so, do the workforce have the necessity skills to be transferred to another product?
will closure of the loss-maker have an adverse effect on the rest of the business? E.g.complementary product
if the loss-maker is to be closed, is it to be a permanent or temporary closure? If permanent, there are likely to be closure costs (eg redundancy payments to staff)
CONTRIBUTION
if a contribution is being made to fixed costs, it should not be closed
if no contribution is being made to fixed costs, then it should be considered for closure (but check that the basis of apportionment of fixed costs is appropriate to each line or production department)
CONCLUSION
A business should continue to operate a loss-making line or production department as long as it is making a POSITIVE CONTRIBUTION
The only exception is if closing the loss-making section would allow a business to operate another line or production department that would generate a higher contribution
Give 3 uses of marginal costing
•Deciding whether to make or buy the product
• Choosing between completing alternative actions
• Acceptance of additional work
• Price setting
• Dealing with a limiting factor
• Closing of a potentially loss-making line or production dept
Give 3 benefits of marginal costing
Only assigns variable fits to the product = simipel and straightforward = speeds up internal decision making
Separating variable from fixed costs allows for more precise monitoring and management of costs
Provides managers with critical data for setting competitive prices, especially in situations where companies are working with excess capacity
Proper recovery of overheads - fixed OH are excluded = no problem of under or over recovery of overheads
the stock of finished goods and work-in-progress are carried on variable cost basis and the fixed expenses are written off to profit and loss account. This shows the true profit of the period
Marginal costing helps in the preparation of break-even analysis which shows the effect of increasing or decreasing production activity on the profitability of the company
helps the management in taking a number of business decisions like make or buy, discontinuance of a particular product, replacement of machines etc
Give 2 limitations of marginal costing
Because MC doesn’t allocate fixed costs to individual products, the inventory valuation may be understated = misleading picture of true cost of production
External financial reporting standards typically require a more comprehensive costing approach e.g. absorption costing, so MC only beneficial internally
Tailored for short-term decision making = May fail to take into account long-term fixed costs implications = short-sighted decisions
Marginal cost ignores time factor and investment. The marginal cost of two jobs may be the same but the time taken for their completion and the cost of machines used may differ.
What 3 factors need to be considered when price setting
The need to make a profit (cost-plus pricing)
Prices of competitive products or services (market-led pricing)
Under-used capacity (marginal cost)
Give 3 factors that need to be considered in Make or Buy decisions
for how long will we need this product or service?
can we find a supplier to make the product or provide the service for us?
is the supplier’s product or service to the specification that we require?
how much do we want to be reliant on another business?
what are the costs involved in the decision and the effect on our profits?
what happens if there are problems with the supplier, e.g. poor quality, late delivery?
what happens at the end of the make or buy contract?
What is an opportunity cost
the benefit that is foregone when a particular course of action is taken
Advise whether the business should use another supplier to overcome the expected shortage of material
FOR:
- Customer satisfaction due to continued supply of products
- Maintain maximum capacity utilisation
- Reducing risk by diversifying supplier base
AGAINST:
- Cost may be higher and especially if the supplier knows that the business requires the materials urgently.
- Loss of a trade discount as there is no established trading history with the supplier.
- Loss of a bulk buying discount and no economies of scale benefit as the quantity is lower due to only buying the extra required and not the total amount.
- quality could be inferior = subsequently impact on the quality of the finished goods = loss of reputation with customers and less sales in the long run
- Potential problems with reliability of delivery = impact further on disruption to production
