Business Insight and Performance Topic 1a

marginal costing (MC)

considers only the variable cost of a product or service

that is a cost which would be avoided if the unit was not produced or provided

direct materials

+ direct labour

+ variable overhead

= marginal cost

marginal cost computation

contribution

an abbreviation of 'contribution towards fixed costs and profit'

the difference between selling price and all variable costs (including non-production variable costs), usually expressed on a per unit basis

selling price

less variable production costs

less variable non-production costs

= contribution

contribution computation

all variable costs

what contribution takes account of

variable product costs only

what marginal costing takes account of

marginal cost

what inventory is valued at

calculating a profit or loss under marginal costing

sales

- variable cost of sales (opening inventory + variable production costs - closing inventory)

- variable selling, distribution, and administration costs

= contribution

- fixed costs (production + selling and distribution + administration)

= net profit

calculating a profit or loss under absorption costing

sales

- cost of sales, including:

opening inventory

+variable production costs

+fixed production overhead absorbed

- closing inventory

= gross profit

- selling, administration etc. costs (non-production)

= net profit

change in stock in unit x OAR per unit

difference in marginal and absorption costing profit

production vs sales

closing inventory vs opening inventory

AC profit vs MC profit

to work out which profit figure is higher compare

SIAM

Stocks Increase Absorption (costing profit is) More

advantages of absorption costing

recognises that selling price must cover all costs

complies with IAS 2 Inventories

disadvantages of absorption costing

profits can be manipulated by changing production levels

based on the assumption that overheads are volume related

advantages of marginal costing

higher contribution so appropriate for decision making

fixed costs treated in accordance with their nature

profit depends on sales and efficiency not production levels

disadvantages of marginal costing

danger that contribution fails to cover fixed costs

does not comply with IAS 2 Inventories

necessitates analysis of mixed costs between fixed and variable