MARGINAL & ABSORPTION COSTING

Marginal Costing This is the accounting system in which variable costs are charged to cost units & fixed costs of the period are written off in full against the aggregated contribution. Marginal cost means the cost of one unit of product or service which would be avoided if that unit were not produced or provided (CIMA official) ie the cost for increase production by a single unit.

Example Rockport Plc is manufacturing firm of garments & they have forecast three situations which will occur for the year ending 31st Dec 2012. For the period they are expecting no: of unit sold will be 600 or 800 or 1200 .Selling price of a single unit is $20 & Rockport has to spend $2 as variable selling overhead. Fixed cost for the period is $3,000. Other costs are as follows. Direct Material Direct Labor Variable Production OH Budgeted Production Prepare Marginal Costing Profit Statement. $8/unit $4/unit $1/unit 1500 units

ROCKPORT PLC PROFIT STATEMENT FOR YE 31st DEC 2012 Expected Sales(Units) Sales Revenue($) A Less: Variable Production Costs Material ($8/unit) Labor ( $4/unit) Production OH ( $1/unit) Less: Selling Expenses($2/unit) Total Variable Costs B CONTRIBUTION A-B Less: Fixed Cost PROFIT Situation 01 600 12,000 (7,800) 4,800 2,400 600 (1,200) (9,000) 3,000 (3,000) NIL Situation 02 800 16,000 (10,400) 6,400 3,200 800 (1,600) (12,000) 4,000 (3,000) 1,000 Situation 03 1200 24,000 (15,600) 9,600 4,800 1,200 (2,400) (18,000) 6,000 (3,000) 3,000

Variable Production cost also simply calculated as addition of all the variable production cost per unit & then multiply it by no: of units expected to sell. Ex : (8+4+1) *600 = $7,800 Contribution per Unit will remain as constant where in Rockport as $5 per unit ( Total Contribution\No: of unit sold) In the scenario Profit NIL means the company is at the Break- even point (BEP). It can be calculated as; TOTAL FIXED COST\CONTRIBUTION PER UNIT Contribution also can be calculated as FIXED COST+PROFIT

Absorption Costing This is the method absorb overheads to the production. For absorbing use Allocation & Apportionment. Allocation means assigning specific OH to production cost center or a cost unit in appropriate basis. Ex: When making plastic products they are using melting, molding & finishing machines. Without taking as a single cost center can be separately identify as three cost centers. Then the costs incurred by each machine can be identifies easily in appropriate manner.

Apportionment means proportionate allotment of OH which are difficult to identify for a specific cost center, can be absorb to production on proportionate basis. Ex : In plastic manufacturing firm supervisors salary cannot be identify for a specific cost center. Therefore the salary is absorbing proportionate basis which is suitable such as time spent on each machinery etc

In here you have to understand how the manufacturing unit is consisting. There can be manufacturing units & also service department. The other thing is there may be reciprocal service method. i.e. service centers providing services to each other(mutually dependant). EX: Mac Plc consisting with two manufacturing departments A & B. They have two service centers Stores & maintenance. Lightning & heating($) Rent Indirect materials Indirect wages Depreciation Total DPT A 15,000 20,000 25,000 4,000 7,500 71,500 DPT B Stores 20,000 6,000 40,000 7,000 30,000 6,000 3,000 9,500 105,500 16,000 Maintenance 2,500 5,000 5,000 12,500

The stores received requisition worth of $20,000 from DPT A, $50,000 from B & $10,000 from the Maintenance. The maintenance workers spent 200hrs in A, 375hrs in B & 50hrs in stores. ANSWER: Basis Of Apportione DPT A DPTB apportionment d total cost Direct N/A 15,000 20,000 Direct Direct Direct Direct Value of Requisition Hrs spent Value of Req Hrs spent Value of req Hrs Spent N/A N/A N/A N/A 16,000 14,500 1,160 145 12 1 20,000 25,000 40,000 30,000 Stores 6,000 7,000 Maintenanc e 2,500 5,000

Lightning & heating Rent Indirect materials Indirect wages Depreciation Sub-total Stores Maintenance Stores Maintenance Stores Maintenance TOTAL

4,000 6,000 3,000 7,500 9,500 71,500 105,500 16,000 4,000 10,000 (16,00 0) 4,640 8,700 1,160 290 725 46 87 12 3 8 (12) 1 80,479 125,021

5,000 12,500 2,000 (14,500) 145 (145) 1 (1)

Also can use instead of reapportion method, building a simultaneous equations or taking the Requisition ratio as 2:5 instead of 2:5:1. Then the calculation will be much easier & shorter.

Calculate absorption rate as follows; Estimate total OH for the department Select an appropriate allocation basis Dividing the total OH by the total of the allocation basis to arrive at an OH absorption rate.

OH ABSORPTION RATE = TOTAL OH ALLOCATED TOTAL OF THE ALLOCATION BASIS

OH absorbed > Actual OH incurred OH absorbed < Actual OH incurred

Over absorption Under absorption

Calculate Profit using Marginal & Absorption costing Format of Absorption costing approach
$ Sales Less : Production costs Direct Material Direct Labor Direct expenses Prime Cost Variable Production OH Fixed production OH Production Cost Diff in opening & closing inventory Cost of goods sold Gross Margin Less: Non manufacturing costs Admin OH Selling & dis OH NET PROFIT $ $ XXX

X X X XX X X XX XX XXX XX X X

XX XXX

Marginal Costing Profit Statement format

Sales Less: Variable costs DM DL Variable OH Diff in opening & closing inventory Total Adjusted VC Contribution Margin Less : Fixed OH Production Admin Selling expenses NET PROFIT X X X (X) XX XXX X X X XXX

XXX XX