Absorption and Marginal Costing | My Assignment Tutor

Business FinanceAbsorption and Marginal CostingWeek 3Absorption Costing• The cost of a product or service is establishedby adding share of overhead to direct cost• Fixed manufacturing overheads absorbed intocosts units• Stock is valued at absorption cost and fixedmanufacturing overhead are charged in theprofit and loss account of the period in whichthe units are soldMarginal Costing• Product or services are valued at theirmarginal cost (Variable cost) only• Fixed cost are treated as period cost andcharged against profit in the period in whichthey relate• Fixed manufacturing overhead are absorbedinto cost unitsAdvantages of Marginal Costing• Marginal costs remain the same, irrespective ofthe volume of production.• When used with standard costing, it gives betterresults.• The differentiation between fixed costs andvariable costs is very helpful in determining theselling price of the products or services.• Sometimes a decision has to be made whether tomanufacture a component or a product or to buyit ready-made from the market.Disadvantages of Marginal Costing• Separation of costs into fixed and variable is adifficult problem• Fixed costs and variable costs are different inthe short run; but in the long run, all costs arevariable.• In the long run all costs change at varyinglevels of operation.• Assumption of sale price will remain the sameat different levels of operationAdvantages of Absorption Costing• This takes account of the fixed overheadsinvolved in the manufacturing process• This includes cost of the product, whichpresents a more realistic cost of a product.• This takes into account all of the costs ofproduction• Provides a company with a more accuratepicture of profitabilityDisadvantages of Absorption Costing• This fails to provide analysis of cost andvolume as variable costing does.• This is not very helpful in taking managerialdecisions such as selection of suitable productmix, whether to buy or manufacture, whetherto accept the export order or not, choice ofalternatives, the minimum price to be fixedduring the depression, number of units to besold to earn a desired profit etcFormats for Absorption CostingDetails P P PSales xProduction cost of salesOpening stock xProduction costDirect material xDirect labor xProduction cost overhead x xCont. FormatxLess closing stock (x) (x)xProduction o/head absorbed xProduction o/head incurred xUnder/over absorbed x or(x)xAdmin o/head incurred xSelling % distribution incurred x (x)Profit xFormat for Marginal CostingDetails P P PSales xVariable cost of salesOpening stock xVariable cost incurredDirect material xDirect labor xVariable Pro cost O/head x xCont. Marginal CostingxLess closing stock (x) (x)variable Production cost of sales xVariable selling and distribution xTotal variable cost of sales (x)Contribution xFixed cost (x)Profit xIllustration (Absorption & MarginalCosting)Chicken & Chips Limited produces a single productZETAS which as the following financial information areprovidedSelling price/unit 30Direct Material per unit 8Direct labour per unit 6Variable overhead per unit 2Fixed overhead incurred 24,000/monthBudgeted production and sales were 10,000 unitsActual production was 8,800 units, but sales were just8,700 unitsSolution for Absorption & MarginalCostingWorkingsAbsorption rate/unit = Fixed o/head/BudgetedProduction & salesAbsorption rate = 24,000/10,000 = 2.4Absorption CostingSales (30x 8,700) 261,000Production cost (8,800 unit)DM (8X8,800) 70,400DL (6X8,800) 52,800V/O/head (2×8,800) 17,600Fixed o/head (2.4x 8,800) 21,120161,920Closing stock (18.4 x 100) (1,840)Cont. Absorption CostingProduction cost of sales 160,080100,920F/Production O/head absorbed 21,120F/Production O/head incurred 24,000Under absorbed fixed o/head (2,880)Profit for the Period 98,040Solution for Marginal CostingSales (30x 8,700) 261,000Variable cost of Production (8,800 unit)DM (8X8,800) 70,400DL (6X8,800) 52,800V/O/head (2×8,800) 17,600140,800Closing stock (16 x 100) (1,600)Variable production cost of sales 139,200Cont. Marginal CostingContribution 121,800Fixed Production costs incurred 24,000Profit for the Period 97,800ReconciliationDifference in profitAbsorption Costing 98,040Marginal Costing 97,800 240Difference in StockAbsorption Costing 1,840Marginal Costing 1,600 240Class IllustrationRice & Peas Enterprise produces a single productCYLINDER which as the following financial informationare providedSelling price/unit 20Direct Material per unit 6Direct labour per unit 4Variable overhead per unit 2Fixed overhead incurred 20,000/monthBudgeted production and sales were 13,000 unitsActual production was 6,900 units, but sales were just6,800 units

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