For obvious reasons it is important that a business does not sell its products and make a loss.
In 1960, Ford dismantled a Mini, examined every nut and bolt, and correctly concluded that Austin-Morris, as it then was, must have been producing the car at a loss. Each Mini sold in the first decade cost its makers £8.
This was obviously poor business practice and why you are learning three costing methods.
Methods of costing you need to know:
1. Marginal costing
Put simply a firm should consider whether a product makes a positive 'contribution' towards the organisations fixed costs.
So what is 'contribution'?
Thinking back to the Mini, lets imagine the selling price was £1000 and the variable or direct cost to make each car was £1008.
In this case there is a negative contribution to fixed costs of £8.
But if they had sold each car for £1250 then there would have been a positive contribution of £242.
Contribution per unit: Selling price
minus variable costs per unit
Total contribution: Total revenue
minus total variable costs
The question below should help you see what might come up in the exam.
2. Standard costing
Within the business production experts, accountants and others will try to work out what the standard cost of a product should be.
They will consider per product or batch:
Direct labour costs
Direct materials costs
Manufacturing costs (variable)
Manufacturing costs (fixed)
After production the actual costs can be compared to the budget costs to work out the variances.3. Absorption costing
This is best explained by looking at the blog entry below.
Difference between direct and indirect costs:
