Absorption and Marginal Costing Methods

Absorption and Marginal embodying MethodsAbsorption belling treats the appeals of all manufacturing components ( curb material, direct labour, variable everywherehead and frozen overhead) as inventoriable or harvest-time lives in accordance with generally accepted accounting principles (GAAP), (BARFIELD et al., 2001).1.2 Marginal CostingVariable be is a terms accumulation method that includes only variable production appeals (direct material, direct labour, and variable overhead) as product or inventoriable cost. (BARFIELD et al., 2001)1.3 Similarities between Both MethodsMarginal costing Absorption costingClosing inventories ar valued at marginal production cost.Closing inventories are valued at honorable production cost. unbending costs are period costs. Fixed costs are absorbed into unit costs.Cost of sales does not include a share of restoreoverheads.Cost of sales does include a share of resolute overheads1.4 Influences of Marginal and Absorption costing on the pr icing policyPricing decisions Since marginal cost per unit is constant from period to period at bottom a short span of time, firm decisions on pricing policy rear end be taken, If fixed cost is included, the unit cost will change from day to day depending upon the people of output.Overhead Variances Overheads are recovered in costing on the pre-determined rates. This creates the problem of treatment of under or over-recovery of overhead, if fixed overhead were included Marginal costing avoids such under or over recovery of overheads.True gain ground It is argued that under the marginal costing technique, the trite of finished goods and work-in-progress are carried on marginal cost basis and the fixed expenses are written off to moolah and loss account as period cost. This shows the true profit of the period.Break-even analysis Marginal costing helps in the preparation of break-even analysis, which shows the effect of increasing or decrease production activity on the profitab ility of the company.Control over expenditure Segregation of expenses as fixed and variable helps the management to exercise control over expenditure. The management can compare the actual variable expenses with the budgeted variable expenses and take corrective action through, variance analysis.Business decision-making Marginal costing helps the management in taking a weigh of business decisions like suck or buy, discontinuance of a particular product, replacement of machines etc.) (BRAGG, STEVEN M., 2007)1.4.1 Influences of Marginal CostingIt recognizes the importance of fixed costs in productionThis method is accepted by Inland Revenue as stock is not undervaluedThis method is always used to modernise financial accountsWhen production remains constant but sales fluctuate absorption costing will show less fluctuation in brighten profit andUnlike marginal costing where fixed costs are agreed to change into variable cost, it is cost into the stock value hence distorting stock va luation. (Accounting for management) (BRAGG, STEVEN M., 2007)1.4.2 Influences of Absorption Costing(It is simple to operate.There are no apportionments, which are frequently done on an arbitrary basis, of fixedcosts. Many costs, such as the merchandise directors salary, are indivisible by nature.Fixed costs will be the same regardless of the volume of output, because they are period costs. Itmakes sense, thus, to charge them in full as a cost to the period.The cost to produce an extra unit is the variable production cost. It is realistic to valueclosing inventory items at this flat attributable cost.Under or over absorption of overheads is avoided.Marginal costing provides the best information for decision making.) (KAPLAN, 2008)Classifications of cost systems in terms of object function, product (services) and behaviour, analysing probable causes of cost variances and offer directors the needed advice to improve performance.2. Cost by Object2.1.1 Direct CostDirect costs are cost s which can be directly identified with a specific cost unit or cost heart. There are three main examples of direct costDirect materials for-example, cloth for making shirtsDirect labour for-example, the wages of the workers stitching the cloth to make the shirtsDirect expenses for-example, the cost of maintaining the sewing machine used to make the shirts.2.1.2 Indirect CostIndirect costs are costs which cannot be directly identified with a specific cost unit or cost perfume. Examples of validating costs include the followingThe total of indirect costs is known as overheads.indirect materials these include materials that cannot be traced to an individual shirt, for example, cottonindirect labour for example, the cost of a supervisor who supervises the shirt makersIndirect expenses for example, the cost of renting the factory where the shirts are manufactured.2.2 Cost by Function2.2.1 Production CostProduction costs are the costs which are incurred when raw materials are convert ed into finished goods and part finished goods (work in progress).3.2.2 Non-Production Cost2Nonproduction costs are costs that are not directly associated with the production processes in a manufacturing organisation.2.3 Cost by behaviour2.3.1 Variable CostVariable costs are costs that tend to vary in total with the level of activity. As activity levels increase then total variable costs will similarly increase.Note that as total costs increase with activity levels, the cost per unit of variable costs remains constant.Examples of variable costs include direct costs such as raw materials and direct labour2.3.2 Fixed CostA fixed cost is a cost which is incurred for an accounting period, and which, within certain activity levels remains constant.Note that the total cost remains constant over a given level of activity but the cost per unit falls as the level of activity increases. (KAPLAN, 2008)Examples of fixed costsrentbusiness ratesExecutive salaries.2.3.3 Stepped Fix CostThis is a type of fixed cost that is only fixed within certain levels of activity.Once the upper limit of an activity level is reached then a new higher(prenominal) level of fixed cost becomes relevant.Examples of stepped fixed costsWarehousing costs (as more space is required, more warehouses must be purchased or rented)Supervisors wages (as the number of employees increases, more supervisors are required).2.3.4 Semi Variable CostSemi variable costs contain both fixed and variable cost elements and are therefore partly affected by fluctuations in the level of activity. Semi variable costs can be shown graphically as followsExamples of semi variable costs Electricity bills (fixed standing charge plus variable cost per unit of electricity consumed) Telephone bills (fixed line rental plus variable cost per call)2.4 guinea pig of Cost Variances(Sales price variances may be caused byunplanned price increases (sales price variance)unexpected fall in demand due to recession (sales volume variance) Materials price variances may be caused bysupplies from different sourcesunexpected general price increasesMaterials usage variances may be caused bya higher or lower incidence of scrapan alteration to product designLabour efficiency variances may be caused bychanges in on the job(p) conditions or working methods, for example, better supervisionconsequences of the learning effect) (BPP, 2007)Responsibility accounting as a system of planning and control of the organisation.3. Responsibility CentresResponsibility accounting systems identify, measure, and report on the performance of people controlling the activities of responsibility centres. Responsibility centre sari classified according to their managers scope of authority and type of financial responsibility. Companies may ready their organizational units in various ways based on management accountability for one or more income-producing factors-costs, revenues, profits, and/or asset base. (BARFIELD et al., 2001)3.1 Cost Centres In a cost centre, the manager has the authority only to incur costs and is specifically evaluated on the basis of how well costs are controlled. Theoretically, revenues cannot exist in a cost centre because the unit does not engage in revenue producing activity. Cost centres commonly include service and administrative departments. For example, the equipment maintenance centre in a hospital may be a cost centre because it does not charge for its services, but it does incur costs. (BARFIELD et al., 2001)3.2 Revenue CentreA revenue centre is strictly defined as an organizational unit for which a manager is accountable only for the generation of revenues and has no control over setting selling prices or budgeting costs. In many retail stores, the individual sales departments are considered independent units, and managers are evaluated based on the total revenues generated by their departments. Departmental managers, however, may not be given the authority to change selling prices to aff ect volume, and often they do not participate in the budgeting process. Thus, the departmental managers might have no impact on costs. (BARFIELD et al., 2001)3.3 Profit CentreIn a profit centre, the manager is responsible for generating revenues and planning and controlling expenses relate to current activity. (Expenses not under a profit centre managers control are those related to long-term investments in plant assets such a touch creates a definitive need for separate evaluations of the subunit anther subunits manager.) A profit centre managers goal is to maximize the centres net income. (BARFIELD et al., 2001)3.4 Investment CentreAn investment centre is an organizational unit in which the manager is responsible for generating revenues and planning and controlling expenses. In addition, the centres manager has the authority to acquire, use, and dispose of plant assets in a mood that seeks to earn the highest feasible rate of return on the centres asset base. (BARFIELD et al., 2001)