Absorption and Marginal Costing Today

8/6/2019 Absorption and Marginal Costing Today

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Absorption and marginal costing


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Def initionAbsorption costing

Marginal costing


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Marginal costingIt is a costing syst em which tr eats only th e

variabl e manu f acturing costs as productcosts. Th e f ixed manu f acturing ov erheadsar e r egard ed as p eriod cost


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CostManu f acturing cost Non-manu f acturing cost

Dir ectMaterials

Dir ectLabour

Overheads

Finish ed goods Cost o f goods sold

Period cost

Prof it and loss account

Absorption Costing

CostManu f acturing cost Non-manu f acturing cost

Dir ectMaterials

Dir ectLabour

Variabl e Overheads

Finish ed goodsCost o f goods sold

Period cost

Prof it and loss account

Marginal Costing

Fixedoverhead


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Todays Obj ectivesYesterday w e look ed at absorption and

marginal costingToday w e will look at th e pr esentation o f incom e statement using both absorptionand marginal costing.We will also look at th eor etical di ffe r ences

between marginal and absorption costing.

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Pr esentation o f costs on incom e statement


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Trading and pro f it ans loss account

Absorption costing Marginal costing $ $

Sales X Sal es XLess: Cost o f goods sold X L ess: Variabl e cost o f

Goods sold XGross pro f it X Product contribution margin X

Less: Exp enses Less: variabl e non- manu f acturingSelling expenses X expensesAdmin. expenses X Variabl e selling expenses XOther expenses X X Variabl e admin. expenses X

Other variabl e expenses XTotal contribution expenses X

Less: Exp ensesFixed selling expenses XFixed admin. expenses XOther f ixed expenses X

Net Pro f it X N et Pro f it X

Variabl e and f ixed manu f acturing


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Exampl e


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A company start ed its busin ess in 2005. The f ollowing in f ormationWas availabl e f or January to March 2005 f or th e company that produc edA singl e product:

$Selling pric e pr e unit 100Dir ect mat erials p er unit 20Dir ect Labour p er unit 10Fixed f actory ov erhead per month 30000Variabl e f actory ov erhead per unit 5Fixed selling ov erheads 1000Variabl e selling ov erheads p er unit 4

Budgeted activity was expected to b e 1000 units each monthProduction and sal es f or each month w er e as f ollows:

Jan F e b MarchUnit sold 1000 800 1100Unit produc ed 1000 1 300 900


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Absorption costing


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January F e bruary March

$ $ $Sales 100000 80000 110000Less: cost o f good sold ($65) 65000 52000 71500

28000 38500Adjustm ent f or Ov er-/(und er )Absorption o f f actory ov erhead 9000 ( 3000 )Gross pro f it 35000 37000 355 00Less: Exp enses

Fixed selling overheads 1000 1000 1000Variabl e selling overheads 4000 3200 4400

Net pro f it 30000 32800 30100


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Marginal costing


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Wk1:Standard fixed overhead rate

= Budgeted total fixed factory overheadsBudgeted number of units produced

= $300001000 units

= $30 units

Wk 2:P roduction cost per unit under absorption costing :

$

Direct materials 20Direct labour 10Fixed factory overhead absorbed 30Variable factory overheads 5

65Bac k


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Wk 3:(U nder-)/Over-absorption of fixed factory overheads :

J anuary February March$ $ $

Fixed overhead 30000 39000 27000Fixed overheads incurred 30000 30000 30000

0 9000 (3000)

1000*$30 1300*$30 900*$30

Wk 4:

Variable production cost per unit under marginal costing :$Direct materials 20Direct labour 10Variable factory overhead 5

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No fixed factory overhead

Bac k


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Diffe r ence between absorptionand marginal costing


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Absorption costing Marginal costing

Tr eatment f or f ixedmanu f acturingoverheads

Fixedmanu f acturingoverheads ar e tr eated as product

costing . It is believed that products cannot b e produc ed without

the r esourc es provid ed by f ixedmanu f acturingoverheads

Fixed manu f acturingoverhead ar e tr eatedas period costs . It is

believed that only th e

variabl e costs ar e r elevant to d ecision-making.Fixed manu f acturingoverheads will b e incurr ed r egardl essther e is production or not


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Valu e of closing stock High value of closing stock will b e

obtain ed as som e f actory ov erheads

ar e includ ed as product costs andcarri ed f orward asclosing stock

Low er valu e of closing stock thatinclud ed the variabl e cost only


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R e port ed pro f it If the production = Sal es, AC pro f it = M C Prof it

If Production > Sal es, AC pro f it > M C pro f itAs som e f actory ov erhead will b e defe rr ed as

product costs und er the absorption costing

If Production < Sal es, AC pro f it < M C pro f it

As th e pr eviously d efe rr ed f actory ov erheadwill b e r eleased and charg ed as cost o f goodssold


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Argum ent f or absorption costing


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Complianc e with th e generally acc e ptedaccounting principl es

Importanc e of f ixed overheads f or productionAvoidanc e of f ictitious pro f it or loss

During th e period o f high sal es, th e production issmall than th e sales, a small er numb er of f ixed

manu f acturing ov erheads ar e charg ed and a high er net pro f it will b e obtain ed und er marginal costingAbsorption costing is b etter in avoiding th e f luctuation o f pro f it being r e port ed in marginalcosting


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Argum ents f or marginal costing


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Mor e r elevanc e to decision-makingAvoidanc e of pro f it manipulation

Marginal costing can avoid pro f it manipulation byadjusting th e stock l evel

Consid eration giv en to f ixed costIn f act, marginal costing do es not ignor e f ixed costs

in setting th e selling pric e. On th e contrary, it provid es usef ul in f ormation f or br eak-even analysisthat indicat es whether f ixed costs can b e conv ertedwith th e chang e in sal es volum e


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Calculat e and explain th e conc e pt o f equival ent unitAbsorption proc ess cost b etween work r emaining in proc ess and trans fers out o f a

proc ess using w eighted av erage and FIFOmethodsPr e par e process accounts in situationswher e work r emains incompl ete and wh er e

losses and gain at di ffe r ent stag es. 27


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THE BASIC PRO CESS OFPRO CESS COSTIN G

Proc ess costing is a costing m ethod us edwher e it is not possibl e to identif y se parat e units o f production, or jobs usually b ecause of continu es natur e of the production

proc ess involv ed.

Exampl es. Oil r ef ining, f ood and drinks,chemical and pap er.

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Featur es of proc ess costingThe output o f one process becomes the input o f the other until th e f inish ed productis mad e in th e f inal proc ess.The continu es natur e of production m eansthat th er e will usually b e closing work in

progr ess which must b e valued.Ther e ar e of ten loss es in th e process du e tospoilag e, wast e, evaporation etc

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Proc ess accountsWher e a series of se parat e processes isr equir ed to manu f actur e the f inish ed

product, th e output o f one proc ess become the input to th e next until th e f inal output ismade in th e f inal proc ess. I f two proc esses

ar e r equir ed the accounts will look lik e the one below.

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Proc ess accounts exampl eProc ess 1 accounts

units $ units $

Dir ect mat erials 1000 50,000 output to proc ess 2 1000 90000Dir ect labour 20,000Production ov erhead 20,000

1000 90,000 1000 90000Process 2

Units $ units $Materials f rom proc ess 1 1000 90000 Output f inish ed 1000 1 50000Added mat erials 30000Dir ect labour 1 5000

Production ov erhead 15000 32


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Fram ework f or dealing with proc ess costing

Ste p 1. d etermin e the output and loss es

Ste p 2 Calculat e cost p er unit o f output,losses and WIPSte p 3. calculat e total cost o f output, loss esand WIPSte p 4. compl ete accounts

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Loss es in proc ess costing Normal loss es Loss expected during th e proc ess. It is not giv en a costAbnormal loss es-Extra loss r esulting wh enactual loss is gr eater than normal or expected loss and is giv en a costAbnormal gain- Is th e gain r esulting wh enactual loss is l ess than th e normal or expected loss and is giv en a n egativ e cost.

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Exampl e of abnormal loss es andgains

Suppos e that input is 1000 units at a cost o f $4500. Normal loss is 10% and th er e ar e noopening or closing stock. De termin e the accounting entries f or th e cost o f outputand cost o f the loss i f the actual output

wer e as f ollows(a) 860 units( so actual loss is 1 40 units )(b)920 units (so actual loss is 80 units )

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Output is 860 units solutionSte p 1 De termin e output and loss es

unitsActual loss 1 40

Normal loss 10%o f 1000 100

Abnormal loss 40

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Ste p 2.calculat e cost p er unit o f output andlosses

The cost p er unit o f output and cost p er unit o f abnormal loss es ar e based on expectedoutput.

Cost incurr ed/Exp ected output=$4500/900=$ 5 per unit

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Ste p 3. calculat e total cost o f output andlosses

Normal loss is not assign ed any cost$

Cost o f output ( 850*$5) 43 00 Normal loss 0Abnormal loss( 40*$5) 200

4500 38


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Ste p 4 compl ete the accountsPRO CESS A CCC OUNTS

units $ units $

Cost incurr ed 1000 4500 normal loss 100 0output 860 (*$ 5) 4300

abnormal loss 40 (*$ 5) 200

1000 4500 1000

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Exercise Now compl ete f or 920 units

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QuestionShiny Inc has two proc esses Y and Z .Ther e is an expected loss o f 5% o f input in

proc ess Y and 7% o f input in proc ess Z.Activity during a f our w eek period is asf ollows

Y ZMaterials input(kg ) 20000 28000Output(kg ) 18500 26100Is th er e an abnormal gain or abnormal loss f or each

proc ess? 41


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SolutionY Z

Input(kg ) 20000 28000

Normal loss(kg ) 1000 1 960Expected output 1 9000 26040Actual output 1 8500 26100Abnormal loss/gain 500(loss ) 60(gain )

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Absorption and Marginal Costing Today

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