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Greetings Dear Sir.
I had two questions bustling in my thought process.
1) Standard costing Chapter:
– Why capacity variance exists for fixed overhead variance only and not for variable overhead variance ?
2) Costing in general
– Is it necessary to put the costing of labour, vo/h, fo/h into a unit ? What if we just take into account the material cost while selling the units into the market just keeping in check that our selling price is higher than the material cost, and treat the labour costs, vo/h & fo/h costs as period costs ?
Proposed benefit – can sell at a much cheaper price rate thus leading to the recovery of all the costs including the proposed period costs quicker due to increased demand from customers, leading to increased profits. To summarize, we would use huge quantity sales to deal with the costs.
I appreciate if you could elaborately guide me, perhaps with examples.
1. There is only a fixed overhead volume variance (which can then be analysed into an efficiency and capacity variance) if we are using absorption costing (not if we are using marginal costing). As I explain in my lectures on this, it is because with absorption costing, the calculation of the sales volume variance is effectively treating the fixed overheads as though they are variable. Of course the fixed overheads are not variable, which is why we need to account for the volume variance.
2. As far as Paper MA is concerned, labour and variable overheads are (along with materials) always variable costs and therefore must be included in the standard cost per unit. If we choose to use marginal costing then fixed overheads are treated as a period cost and are not included in the standard cost. If we choose to use absorption costing then we do include fixed overheads in the standard cost per unit.
Although pricing is not examinable until Paper PM, whichever method of costing is being used, the fixed costs still need to be covered if the business is to make a profit. Just selling at a price greater than the marginal cost will only result in a profit if the total contribution resulting is more than enough to cover the fixed costs.1. Doubt cleared. Very well put.
2. I am just asking in general. I was saying if we just account for material cost, and ignore the rest of the variable costs and fixed cost and treat them all as period costs, wont that indeed be a great way to reduce selling price to reach huge sales quantity, via which we can make up for all the proposed period costs and still make huge profits due to our very low selling price.
Firstly they are not period costs (which would imply that they were fixed costs).
Secondly a lower selling price does not necessarily mean more sales (competitors might reduce their prices) – but this is Paper PM.
Thirdly, whether or not there are more sales, the contribution still has to be more than all of the fixed costs if they are to make a profit.
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