Difference between absorption costing and marginal costing.

Absorption costing is a method whereby all production costs are charged to units of production. Marginal costing is a method whereby variable production costs only are charged to units of production and the fixed costs are treated as a cost of the accounting period. The main differences between the two methods: 1. If the opening and closing inventory levels differ, the profit reported under the two methods will also be different. In the long run, total profit under the two methods will be the same. 2. Marginal costing is more useful for decision-making purposes, but absorption costing is needed for financial reporting purposes to comply with accounting standards.

Explain why absorption costing will produce higher profit than marginal costing.
In marginal costing, inventories are valued at variable production cost, whereas, in absorption costing, inventories are valued at their full production cost. So, if the opening and closing inventory levels differ, the profit reported under the two methods will also be different. If opening inventory values are less than closing inventory values, profit under absorption costing will be lower than that under marginal costing. If opening inventory values are higher than closing inventory values, profit under absorption costing will be greater than that under marginal costing.

Briefly outline the steps involved in allocating overheads using activity based costing.
Identify the organizations major activities. Collect the costs associated with each activity into cost pools. Identify the cost drivers i.e. those factors which give rise to the costs. Charge the costs to the products on the basis of the cost driver.

Why activity-based costing may be preferred to traditional absorption costing in the modern manufacturing environment.
Absorption costing uses volume as a basis for cost allocation. Therefore it tends to allocate too great a proportion of overheads to high volume products and too small to low volume products. ABC uses several bases or cost drivers to allocate overheads and as such will more closely link overhead allocations to the causes of overhead costs. Therefore ABC recognizes the complexity of manufacturing in its use of multiple cost drivers and so more detailed cost information is available. ABC also enables a good understanding of what drives overhead costs as it accumulates a good deal of data for analysis. Therefore ABC can be used as an information source for budget planning based on activity rather than incremental budgeting. ABC also establishes a long run product cost.

Implementation problems often experienced when ABC is first introduced.

Lack of data ABC requires detailed accounting records which may not be available in the business. Information is required on cost pools and cost drivers. This information is usually time consuming to derive and there may be resistance from employees. Identifying cost drivers It may be difficult to identify a single cost driver which explains the behavior of all items in its associated pool. Lack of understanding ABC is a complex, time consuming technique which will not necessarily be sufficiently understood and accepted by managers to enable them to provide meaningful product costs or extra information. The costs of implementation ABC may exceed the benefits.

Explain the main steps involved in developing a target price and target cost for a product in a typical manufacturing company.
Step 1: Step 2: Step 3: Step 4: Step 5: Step 6: Step 7: Step 8: Determine a product specification of which an adequate sales volume is estimated. Set a selling price at which the organization will be able to achieve a desired market share. Estimate the required profit based on return on sales or return on investment. Calculate the target cost = target selling price target profit Compile an estimated cost for the product based on the design specification and current cost levels. Calculate target cost gap = estimated cost target cost. Make efforts to close the gap. Negotiate with the customer before deciding whether to go ahead with the project.

Explain four key characteristics that distinguish services from manufacturing.

Spontaneity: a service is consumed at the exact same time as it is made available. No service exists until it is being experienced by the consumer. Heterogeneity/variability: services involve people and, because people are all different, the service received may vary depending on which person performs it. Standardization is expected by the customer but it is difficult to maintain. Intangibility: unlike goods, services cannot be physically touched. Perishability: unused capacity cannot be stored for future use. No transfer of ownership takes place when a service is provided. Service industries rely heavily on their staff, who often have face-to-face contact with the customer, and represent the organizations brand.

Benefits of adopting target costing.

External focus

Traditionally the business use an internal focus when developing a new product by calculating the cost and then adding a margin to get a selling price. Target costing makes the business look at what competitors are offering at a much earlier stage in the development process.

Customer focus Customer requirements for quality, cost and time are incorporated into product and process decisions. The value of product features to the customers must be greater than the cost of providing them and only those features that are of value to customers are included. Cost control Cost control is emphasized at the design stage so any engineering changes must happen before production starts. Faster time to market The early external focus enables the business to get the process right first time and avoids the need to go back and change aspects of the design and/or production process. This then reduces the time taken to get a product to the market.

Discuss the benefits of life cycle costing.

Life cycle costing tracks and accumulates actual costs and revenues attributable to each product over its entire life cycle. The total profitability of any given product can be determined, meaning that prices can be set with better knowledge of the true costs. Life cycle costing shows all costs relating to product rather that relating to single period, thus providing more accurate information for decision making. The costs of researching, developing and designing products are also taken into account. This will allow more accurate analysis when measuring the performance of new products.

Explain the principles and limitations of throughput accounting.