Quiz & Flashcards on Make or Buy Decisions in Marginal Costing

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Questions and Answers

In the context of marginal costing, how is decision making simplified in make or buy scenarios?

By bifurcating total costs into fixed and variable components (correct)

By considering only fixed costs for decision making

By ignoring variable costs

By comparing historical costs with current purchase costs

Why is the application of absorption costing considered misleading in make or buy decisions?

It does not consider variable costs (correct)

It values finished goods stocks at variable costs only

It values work-in-progress inventory at fixed costs only

It overestimates fixed costs

How does marginal costing ensure a more realistic valuation of stock compared to other methods?

By inflating profits through fictitious valuations

By ignoring fixed costs in inventory valuation

By including non-manufacturing overheads in valuation

By valuing stocks at variable costs only (correct)

What does marginal costing provide to help maintain or achieve a desired level of profits?

Information on reducing variable costs or increasing selling price Signup and view all the answers

How does marginal costing facilitate cost control compared to other costing methods?

By separating fixed and variable costs for better cost control Signup and view all the answers

In what context are key factor problems relevant in businesses?

When facing constraints limiting business operations Signup and view all the answers

What helps in better evaluation of different divisions based on cost-volume-profit analysis?

Contribution ratio Signup and view all the answers

Why is responsibility accounting more effective when based on marginal costing?

Managers' responsibilities are evaluated based on contribution Signup and view all the answers

In the short-run, what remains consistent in marginal costing, facilitating better decision making?

Marginal cost per unit of output Signup and view all the answers

Which factor is considered when making buy or make decisions in marginal costing?

Contribution margin Signup and view all the answers

What does marginal costing help in maintaining for a business operation?

Desired level of profit Signup and view all the answers

How does marginal costing contribute to realistic valuation of stock?

By focusing on variable costs Signup and view all the answers

What is a challenge in adopting marginal costing in capital intensive industries?

Difficulty in distinguishing between fixed and variable costs Signup and view all the answers

Why is it not advisable to fix selling prices based solely on contribution under marginal costing?

Risk of selling too much at marginal cost Signup and view all the answers

What is a limitation of using marginal costing for performance evaluation?

Lack of standard for evaluation Signup and view all the answers

How does marginal costing help in maintaining the desired level of profit?

Helping ascertain the lowest selling price per unit without loss Signup and view all the answers

Why may fixing selling prices under marginal costing be challenging in 'cost plus contracts'?

'Cost plus contracts' may conflict with marginal costing principles Signup and view all the answers

Why is it difficult to adopt marginal costing in multi-product businesses?

Challenges in calculating contribution margins Signup and view all the answers

Study Notes

Decision-Making in Make or Buy Scenarios

Marginal costing simplifies decision-making by focusing on variable costs, helping businesses assess financial impacts of in-house production versus purchasing.
Absorption costing can mislead decisions as it includes fixed costs in product costs, leading to potentially erroneous conclusions about profitability.

Valuation of Stock

Marginal costing provides a realistic stock valuation by only considering variable costs, which aligns inventory values more accurately with current production expenses.
Under absorption costing, stock values can become inflated by including fixed overheads, distorting true profitability.

Profit Maintenance

Marginal costing offers insights into cost behavior and contribution margins, essential for maintaining or achieving targeted profits.
It allows businesses to identify necessary sales levels to cover variable costs and maintain desired profit margins.

Cost Control

Marginal costing facilitates effective cost control by clearly distinguishing fixed and variable costs, enabling managers to monitor and manage costs more effectively.
It emphasizes direct variable costs, which can be adjusted more readily to respond to changes in business conditions.

Key Factor Problems

Key factor problems arise when limited resources hinder production capacity. They help prioritize resource allocation and optimize profitability.

Cost-Volume-Profit Analysis

Cost-volume-profit analysis under marginal costing allows better evaluation of different divisions by examining their contribution margins and variable costs directly.
This analysis assists in understanding how varying sales levels affect profitability and resource utilization.

Responsibility Accounting

Responsibility accounting is more effective with marginal costing as it aligns performance assessment with controllable costs, simplifying accountability for managers.

Consistency in Decision Making

In the short-run, variable costs remain consistent within marginal costing, aiding predictability and decision-making regarding production and pricing.

Buy or Make Decisions

When making buy or make decisions, marginal costing emphasizes the variable cost impact of each option, facilitating informed choices based on direct costs.

Maintenance of Business Operations

Marginal costing helps maintain operational efficiency by ensuring that decisions are aligned with variable cost management and profitability targets.

Challenges in Capital Intensive Industries

Adopting marginal costing in capital-intensive industries can be challenging due to high fixed costs, which may be underrepresented in variable cost analyses.

Selling Prices and Contribution

Fixing selling prices solely based on contribution under marginal costing may not account for necessary recovery of fixed costs, risking profit margins.

Performance Evaluation Limitations

A limitation of marginal costing for performance evaluation is its potential oversimplification, which might neglect long-term fixed cost implications.

Maintaining Desired Profit Levels

Marginal costing aids in maintaining desired profit levels by providing relevant data on cost behavior and margin contributions for setting sales targets.

Challenges in 'Cost Plus Contracts'

Fixing selling prices under marginal costing in cost-plus contracts can be challenging as it may overlook the importance of fixed costs in overall pricing strategies.

Multi-Product Business Complexity

In multi-product businesses, adopting marginal costing may be difficult due to the varying contribution levels and resource allocations required for different products.

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Description

This quiz covers how marginal costing helps in decision-making between in-house manufacturing and market purchase of components. Learn about bifurcation of total costs, comparison of variable costs, and the application of marginal costing over absorption costing for accurate decision-making.

Make or Buy Decisions in Marginal Costing

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