Topic 7- Absorption & Marginal Costing

ACOF 014 Introduction to Costing Semester 2 2008/ 2009 TOPIC 7: ABSORPTION

AND

MARGINAL COSTING

Outline: 1. Learning Objectives 2. Differences between absorption and variable costing 3. Impact on profit under each costing technique 1. Learning objectives a. Explaining the differences between absorption costing and marginal costing b. Explaining the impact on stock valuation & profit under each costing system c. Explaining the impact on under each costing system d. Preparing multi-period absorption and marginal costing profit statements 2.

Explaining the differences between absorption costing and Marginal costing 298) Flow of Costs under Full Absorption & Marginal Costing

PERIOD COST Selling and administrative expenses

FULL ABSORPTION COSTING PRODUCT COSTS Fixed manufacturin g overhead

Variable manufacturing overhead

Direct materials and direct labour

Work in process inventory

Cost of goods sold

Expenses for the period

PERIOD COST Selling and administrative

Closing inventories

MARGINAL COSTING PRODUCT COSTS Fixed manufacturin

Variable manufacturing

Direct materials and 1

expenses

g overhead

overhead

direct labour

Work in process inventory

Cost of goods sold

Expenses for the period

Closing inventories

Absorption Costing = full costing - DM + DL + Marginal + fixed manufacturing OH  product cost - Non-manufacturing cost  period cost Marginal Costing (Variable/ Direct Costing) DM + DL + Marginal manufacturing OH  product cost Fixed manufacturing OH + non-manufacturing cost  period cost Which method should be used? External reporting  use absorption Costing Match costs against revenues. ** absorption costing  may have under/over recovery of fixed overheads  charged to I/S as period costs (refer Topic #4 on OH) Internal reporting  debatable  both useful in different ways The Concept of Contribution Margin MARGINAL COST =

VARIABLE COST =

DIRECT LABOUR + DIRECT MATERIAL + DIRECT EXPENSE + VARIABLE OVERHEADS

CONTRIBUTION MARGIN = SALES – MARGINAL COST  the contribution margin (CM) is the excess of sales revenues over varibale costs  in other words, CM is the amount available to cover the fixed costs, once they are covered, any remaining amounts adds directly to the income form the operations. CM could also be expressed in total or per unit of product.

Illustration 1: Contribution Margin Income Statement Sales Variable costs

RM 1,000,000 600,000

2

CM

RM

400,000

Fixed costs Income from operations

Available to cover the FC of RM300,000.

300,00 RM

100,000

(note: think of the fixed costs as a bucket and the CM is water filling the bucket. Once the bucket is filled, the overflow represents income from operations. Up until the point of overflow, however, the CM contributes to fixed costs (filling the bucket)).

3. Preparing multi-period absorption and marginal costing profit statements Illustration 2: The unit cost of production for a firm which produces a single product is: Direct materials 2.60 Direct labour 3.00 Variable overhead 0.40 Fixed overhead 1.00 7.00 The fixed overhead calculation is based on a budgeted level of activity of 150,000 units and budgeted manufacturing fixed overheads f RM150,000 for each quarter. The budgeted selling and administration overheads are RM100,000 per quarter (all fixed). The selling price for the product is RM10 per unit. The production and sales for each quarter were: Quarter 1 Production (units) 150,000 Sales (units) 150,000

Quarter 2 Quarter 3 170,000 140,000 150,000 140,000 160,000 160,000

Quarter 4

There was no opening stock in Quarter 1 and you should assume that actual costs were identical to estimated costs. You are required to: a) produce in columnar format, absorption and variable costing profit statements b) comment on the results for each quarter and the year as a whole

Illustration 3: Assume, for example, that on June 1, Hamilton Manufacturing Company opened a new plant in Nashville. Data for the plant's first month of operations are as follows: 3

Units manufactured and units sold: Number of units manufactured (all completed by June 30) Number of units sold Units in inventory of finished goods at June 30 Sales revenue and selling and administrative expenses: Net sales (10,000 units sold @ $20) Selling and administrative expenses: Variable (RM2 per unit sold) Fixed

11,000 101,000 1,000 RM 200,000 RM 20,000 RM 30,000

Required: (a) Prepare manufacturing costs (per unit manufactured) statement under both costing systems (b) Prepare partial income statement under both costing systems

4. Explaining the impact on stock valuation & profit under each costing system Impact on Profit: Production = sales  Absorption costing π = Marginal costing π (i.e. stocks value do not ↑ or ↓, ( same amount of FOH included as expense and as closing stock) Production > sales  Absorption costing π > Marginal costing π (i.e. when there are units produced that become closing stock) AC: closing stock ↑ as FOH included  higher closing stock  ↑π VC: closing stock ↓ as FOH NOT included Production < sales  Absorption costing π < Marginal costing π (i.e. when part of the units sold covered by opening stock) AC: closing stock ↓ because less FOH charged to production  ↓ closing stock ↓π Problems: under Absorption Costing  profit decrease even though sales up and SP and cost structure unchanged Why? Due to under/ over recovery of FOH in AC

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

INCOME STATEMENT FORMATS  Marginal Costing/Marginal Costing/Direct Costing  the CVP format:

Income Statement for the ended xx/xx/xxxx _____________________________________________________________________________________________ Sales ………………………………………………………………….............. xxxxx Marginal expenses: Beginning inventory ……………………………………………............xxx Marginal manufacturing costs …………………………………….......xxx Cost of goods available for sale …………………………………....... xxx Closing inventory …………………………………………………..........(xxx) Marginal cost of goods sold ……………………………………….......xxx Marginal selling and administrative expenses ……………………. xxx Total Marginal expenses ………………………………………......

(xxxx)

Contribution margin …………………………………………………............

xxxxx

Fixed expenses: Manufacturing overhead ………………………………………….........xxx Selling and administrative ……………………………………….........xxx Total fixed expenses …………………………………………. .......

(xxxx)

Net Profit (Loss) from operations ……………………………………........

xxxx

 Absorption Costing/Full Costing Income Statement for the ended xx/xx/xxxx Sales …………………………………………………………………..............

xxxxx

Less: Cost of Goods Sold: Beginning inventory ……………………………………………............ xxx Total production cost ……………………………………………...........xxx Cost of goods available for sale ………………………………….......xxx Closing inventory …………………………………………………..........(xxx) Cost of goods sold ……………………………………………………...........

(xxxx)

Adjustments for (Under)/Over recovery of overheads …………….. Gross Profit …………………………………………………………................

xxxxx

Non-manufacturing overheads/expenses …………………………….....

(xxxx)

Net Profit (Loss) from operations ……………………………………........

xxxx

(xxxx)

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 Example Questions:

1. Zeera Limited manufactures a single product, the budgeted selling price and Marginal cost details of which are as follows: Selling price Marginal costs per unit: Direct materials Direct labour Marginal overhead

RM 15.00 3.50 4.00 2.00

Budgeted fixed overhead costs are RM60,000 per annum, charged at a constant rate each month. Budgeted production is 30,000 units per annum. In a month when actual production is 2,400 units and exceeded sales by 180 units the profit reported under absorption costing was: a. b. c. d. e.

RM6,660 RM7,570 RM7,770 RM8,200 RM8,400

2. A company made 10,000 units at a total cost of RM20 each. Three-quarters of the costs were Marginal and one-quarter fixed. 8,000 units were sold at RM30 each. There were no opening stocks. Calculate the profits under both the absorption and marginal costing system.

Tutorial Questions: 6

1.

NyumNyum Ltd. starts business on 1 July, making product Roro. The standard cost for Roro is as follows: RM Direct labour 5 Direct material 8 Variable production overhead 2 Fixed production overhead 5 Total standard production 20 cost The fixed production overhead figure has been calculated on the basis of a budgeted normal output of 36,000 units per annum. You are to assume that all budgeted fixed expenses are incurred evenly over the year. Selling, distribution and administration expenses are: Fixed

RM120,000 per annum

Variable

15% of the sales value

The selling price per unit is RM35 and the number of units produced and sold was:

Production Sales

July (units) 2,000

August (units) 3,200

1,500

3,000

Required: Prepare profit statements for each of the months of July and August using: a) marginal costing b) absorption costing 2. The data below relate to Buat Taktau Company which makes and sells one product. There was no stock at the beginning of August. August September Units Units Sales 4,000 6,000 Production 8,000 2,000 RM RM Selling price per unit 80 80 Variable production costs per unit 40 40 Fixed production overhead incurred 96,000 96,000 Fixed production overhead cost per unit, being the predetermined overhead absorption rate 12 12 Fixed selling, distribution and administration costs

40,000

40,000

Required: a) Prepare comparative profit statements for each month using: (i) Absorption costing; (ii) Marginal costing. 1.

Give two examples where marginal costing is used.

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3. A company, “Macam-Macam Ada” Enterprise which located in Taman Setiawangsa, manufactures and sells supplement product, “E-Nergy”. The company provides the standard production costs of which is as follows for one unit of product:-

Direct Materials (4 kg x RM5/kg) Direct Labour (2 hours x r5/hr) Variable production overhead Selling Price

RM 20 10 8 60

Fixed production overhead for the company is RM32,000, which is constant throughout the year. The company has normal capacity of production units at 16,000 units per annum. Other expenditures which relating to selling and distribution are as follows:Variable : 10% of Sales Values Fixed

: RM18,000 per annum

Since this is the first year of company’s operations of its business, therefore there is no opening stock for the year 2006.

Sales (units) Production (units)

2006 7,000 9,000

2007 8,500 11,000

Rquired: a) Prepare profit statement using Marginal Costing for BOTH years. b) Prepare profit statement using Absorption Costing for BOTH years. 4. Textbook Drury: Question 8.16 (page 234-235).

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