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Absorption and Marginal Costing
Absorption and Marginal Costing
Introduction
Definition
Absorption costing
Marginal costing
Absorption costing
Marginal costing
Absorption Costing
Cost
Manufacturing cost
Direct
Materials
Direct
Labour
Non-manufacturing cost
Overheads
Finished goods
Marginal Costing
Direct
Labour
Finished goods
Cost
Manufacturing cost
Direct
Materials
Period cost
Non-manufacturing cost
Variable
Overheads
Fixed
overhead
Period cost
Profit and loss account
6
Marginal costing
$
X
X
X
Net Profit
Sales
Less: Variable cost of
Goods sold
Product contribution margin
$
X
X
X
X
X
X
X
Less: Expenses
Fixed selling expenses
Fixed admin. expenses
Other fixed expenses
Net Profit
X
X
X
X
Example
Required:
11
Absorption costing
12
January
$
Sales
100000
Less: cost of good sold ($65) 65000
Adjustment for Over-/(under)
Absorption of factory overhead
Gross profit
35000
Less: Expenses
Fixed selling overheads 1000
Variable selling overheads 4000
Net profit
30000
February
$
80000
52000
28000
March
$
110000
71500
38500
9000
37000
(3000)
35500
1000
3200
32800
1000
4400
30100
13
Marginal costing
14
January
$
100000
Sales
Less: Variable cost of good
sold ($35)
35000
Product contribution margin 65000
Less: Variable selling overhead4000
Total contribution margin
61000
Less: Fixed Expenses
Fixed factory overhead 30000
Fixed selling overheads 1000
Net profit
30000
February
$
80000
March
$
110000
28000
52000
3200
48800
385500
71500
4400
67100
30000
1000
32800
30000
1000
30100
15
Wk1:
Standard fixed overhead rate
= Budgeted total fixed factory overheads
Budgeted number of units produced
=
$30000
1000 units
= $30 units
Wk 2:
Production cost per unit under absorption costing:
Direct materials
Direct labour
Fixed factory overhead absorbed
Variable factory overheads
Back
$
20
10
30
5
65
16
Wk 3:
(Under-)/Over-absorption of fixed factory overheads:
January
February
March
$
$
$
Fixed overhead
30000
39000
27000
Fixed overheads incurred 30000
30000
30000
0
9000
(3000)
1000*$30
1300*$30
900*$30
17
18
Absorption costing
Treatment for Fixed
fixed
manufacturing
manufacturing overheads are
overheads
treated as product
costing. It is
believed that
products cannot be
produced without
the resources
provided by fixed
manufacturing
overheads
Marginal costing
Fixed manufacturing
overhead are treated
as period costs. It is
believed that only the
variable costs are
relevant to decisionmaking.
Fixed manufacturing
overheads will be
incurred regardless
there is production or
not
19
Value of
closing stock
Absorption costing
High value of
closing stock will be
obtained as some
factory overheads
are included as
product costs and
carried forward as
closing stock
Marginal costing
Lower value of
closing stock that
included the variable
cost only
20
Absorption costing
Marginal costing
Reported If the production = Sales, AC profit = MC Profit
profit
If Production > Sales, AC profit > MC profit
As some factory overhead will be deferred as
product costs under the absorption costing
If Production < Sales, AC profit < MC profit
As the previously deferred factory overhead
will be released and charged as cost of goods
sold
21
22
23
24
Break-even analysis
26
Definition
27
Application
Relevant range
Fixed cost
Variable cost
Sales revenue
30
Cost $
Total cost
Variable cost
Fixed cost
Sales (units)
Total Cost/Revenue $
Sales revenue
Profit
Total cost
BEP
Sales (units)
31
Calculation method
32
Calculation method
Breakeven point
Target profit
Margin of safety
Changes in components of breakeven
analysis
33
Breakeven point
34
Calculation method
35
Formula
Breakeven point
Fixed cost
=
Contribution per unit
Sales revenue at breakeven point
= Breakeven point *selling price
36
Alternative method:
Sales revenue at breakeven point
Contribution required to breakeven
=
Contribution to sales ratio Contribution per unit
Breakeven point in units
Sales revenue at breakeven point
=
Selling price
37
Example
Selling price per unit
Variable cost per unit
Fixed costs
Required:
$12
$3
$45000
38
Fixed costs
Contribution per unit
= $45000
$12-$3
= 5000 units
39
Alternative method
Contribution to sales ratio $9 /$12 *100% = 75%
Sales revenue at breakeven point
= Contribution required to break even
Contribution to sales ratio
= $45000
75%
= $60000
Breakeven point in units = $60000/$12 = 5000 units
40
Target profit
41
Formula
No. of units at target profit
Fixed cost + Target profit
=
Contribution per unit
Required sales revenue
Fixed cost + Target profit
=
Contribution to sales ratio
42
Example
Selling price per unit
Variable cost per unit
Fixed costs
Target profit
Required:
$12
$3
$45000
$18000
44
Alternative method
Required sales revenue
Fixed cost + Target profit
=
Contribution to sales ratio
$45000 + $18000
=
75%
= $84000
Units sold at target profit = $84000 /$12 = 7000 units
45
Margin of safety
46
Margin of safety
47
Formula
Margin of safety
= Budget sales level breakeven sales level
Margin of safety
= Margin of safety *100%
Budget sales level
48
Sales revenue
Total Cost/Revenue $
Profit
BEP
Total cost
Sales (units)
Margin of safety
49
Example
The breakeven sales level is at 5000 units.
The company sets the target profit at
$18000 and the budget sales level at 7000
units
Required:
Calculate the margin of safety in units and
express it as a percentage of the budgeted
sales revenue
50
Margin of safety
= Budget sales level breakeven sales level
= 7000 units 5000 units
= 2000 units
Margin of safety
= Margin of safety *100 %
Budget sales level
= 2000 *100 %
7000
= 28.6%
The margin of safety indicates that the actual sales can fall by
2000 units or 28.6% from the budgeted level before losses are
incurred.
51
Changes in components of
breakeven point
52
Example
$12
$3
$45000
$18000
53
= 6300 units
54
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