Funfair Engineering Ltd manufactures fairground equipment. The company uses absorption costing and has been experiencing falling demand for its products due to the economic recession. Steve Wrench, the production manager, is worried because the total cost per unit is increasing, despite strict cost controls. Diane Flowers, the marketing manager, is complaining that selling prices will have to be reduced to maintain sales levels. At a recent meeting they found that the selling price suggested by Diane is lower than the total cost per unit calculated by Steve and they concluded that lowering the selling price to increase sales will only lead to even larger losses.

Required Write a report addressed to Mr Wrench and Ms Flowers explaining:

(a) Why the total cost per unit increases as production decreases.

(b) Why marginal costing may be more appropriate than absorption costing for decision making in times of recession.