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Chapter 9 - absorption costing a marginal costing - Coggle Diagram
Chapter 9 - absorption costing a marginal costing
absorption costing
a product cost consists of direct costs direct material costs and direct labor costs and a share of manufacturing overheads. Normal manufacturing overheads are treated as. Costs. Financial statements produced for external purposes are based on this concept of product costs
Marginal cost and is an internal reporting alternative to absorption costing. Marginal costing reports are particularly useful to management for decision-making purposes. In marginal costing costs are classified according to their behavior into their fixed and variable components. Unless provided with additional information draft calls are assumed to be variable calls. And marginal costing the term contribution is often used were
Contribution equals sales minus variable costs
Product cost/cost of inventory using marginal costing and absorption costing
In marginal costs in each unit of inventory and unit produced is valued at the variable production cost only IE fixed production costs are not included in the unit cost of each product
In absorption costing each unit of inventory and each unit produced is valued at the full production costs. This means that every unit of inventory and unit produced must include a share of the fixed production overheads
Fixed production overheads
In marginal costing the actual fixed production overhead costs incurred are charged as one figure in the profit statement
In absorption costing fixed production overheads are charged to products based on a predetermined overhead absorption rate. This means that the number of fixed overheads absorbed into production may be different to the actual effects overhead costs incurred. A subsequent adjustment for the under or over absorption of fixed production their heads must be calculated
Arguments in favour of marginal costing
The distinction between variable costs and fixed costs is easy to understand
Marginal costing is a useful short term survival costing technique in an extremely competitive business environment where an order is accepted if it covers the marginal cost of the order and any access over the marginal cost contributes towards fixed costs so that losses are minimized
Marginal costing shows the relationship between cost selling price and volume
Under absorbed overheads or over absorbed overheads do not arise in marginal costing
Marginal costing provides more useful information for decision making purposes
Marginal costing concentrates on the controllable aspect of business by separating fixed costs and variable costs
The effect of production and sales policies is more clearly seen and understood
Marginal costing removes the impact of fluctuating inventory levels on profit
Marginal costing ties in with standard crossing systems and budgetary control
Disadvantages of marginal costing
Marginal costing makes use of historical data while decisions by management relate to future events. Marginal costing does not consider the effects of inflation
Marshall carlson ignores fixed costs used to produce products as if they are not important to production
Marginal crossing fields recognized that eventually fixed costs may become variable costs
Marginal costing oversimplifies costs into fixed costs and variable costs as if it is so simple to distinguish them
marginal costing is not a good costing technique overall for pricing decisions as it ignores fixed costs. Eventually businesses must cover their total cost not just their variable costs
It is difficult to classify variable costs and fixed costs perfectly hence inventory valuation can be distorted if fixed costs are classified as variable cost
Arguments in favour absorption costing
Absorption costing is consistent with external reporting requirements
Absorption costing has traditionally been the preferred costing approach
Flex production overhead is necessary for production and should be part of a production cost
Fear fluctuation and profit when production is constant, but sales fluctuate as the fixed production overhead is carried and inventory values
Disadvantages of absorption costing
As absorption costs in place emphasis on total cost it is not so useful for management to keep planning and control decisions
As the management emphasis is on total cost the cost following profit relationship is ignored. The managers need to use his intuition to make this decision
Calculation of under/over absorption effects production overheads required
Other techniques such as activity based caused and provides more accurate product costs than observation costing