A3-comparing different costing methods and systems

Question 1

1. absorption costing VS marginal costing

differences in the PL

Answer 1

1. valuing units
   - AC valued at total production cost
   - MC valued at variable cost
2. valuing inventories
   - AC opening and closing inventory are valued at total production cost
   - MC opening and closing inventory are valued at marginal cost
3. treatment of fixed overheads
   - AC carried forward from one period to another as part of the closing (opening) inventory valuations
   - MC fixed costs are charged in full against profit in the period in which they are incurred.
4. adjusting for under or over absorption
   - AC an adjustment for under or over absorption of overheads is made in the statement of PL
   - MC no adjustment

Question 2

2. absorption costing VS full costing

implications on princing

Answer 2

1. under marginal costing
   - fixed overheads are ignored when establishing the unit costs for our domestic products and the costs associated with commercial jobs.
2. under full costing
   - allow to establish the total cost to make our products
   - give a base against which we can compare the prices that we are able to achieve in the market.
   - more accurate information about the relative profitablity of our products.

Question 3

3. use the ABC or not

Answer 3

1. under the current system , a product would be charged relatively lower production overheads since the current system is based on labour hours, however this may not adequately reflect the resources being consumed by the product.
2. using an ABC system, the individual processes would be treated as separate activities and the cost would be accumulated in cost pools. the cost driver of each cost pool, that is the factor that causes the cost to be incurred, would be determined and the costs would be charged to production in relation to the specific demands of the product on each activity.

Question 4

4. how to implement the ABC

Answer 4

1. we would look at our overhead costs in a lot more detail by identifying production areas and then for each production area break it down into activities.
2. each activity would have its own cost centre(known as a cost pool) into which all the costs associated with the activity would be collated.
3. we would not use direct labour hours as the basis for absorbing each of the overhead cost pools. instead each cost pool would be absorbed on the basis of a cost driver, that is the activity or action that dirives or generates the cost.

Question 5

5. how to describe “not volume related”

part A

Answer 5

1. our current absorption costing system assumes that overhead cost relate to volume and shares the costs using direct labour hours.
2. additionally, we use a factory-wide absorption rate which means that costs are not identified for individual production departments or processes. instead the total overhead cost for the factory are divided by the total labour hours to arrive at an absorption rate per labour hour.

Question 6

6. how to describe “not volume related”

part B

Answer 6

in any manufacturing process, there will be costs which do not relate to volume but rather will be batch related.
1. for example, machine set-up costs will depend on the number of times that the machines are set-up.
if we assume that the machines are set-up each time a batch is produced, then a product which is produced in smaller batch sizes will require relatively more machine set-ups than a product produced in larger batches.
2. in this case, a product in smaller batch sizes than b product therefore a product should be charged a relatively higher proportion of production overheads relating to set-up costs.