Marginal & Absorption Costing ST Academy With Solution

6.
0 Marginal and Absorption Costing SAUD TARIQ

CAF 03 Cost and Management Accounting
ST Academy
Marginal and Absorption Costing
Costing
Absorption Costing Marginal Costing
Used in Finacial
Used in Decision
Accounting
Making
(reporting purpose)
Absorption costing is a method of product costing which aims to include in the total cost of a product
(unit, job and so on) an appropriate share of an organisation's total overhead, which is generally taken
to mean an amount which reflects the amount of time and effort that has gone into producing the
product.
The choice of an absorption basis is a matter of judgement and common sense. There are no strict
rules or formulae involved. But the basis should realistically reflect the characteristics of a given
cost centre, avoid undue anomalies and be 'fair'. The choice will be significant in determining the
cost of individual products, but the total cost of production overheads is the budgeted overhead
expenditure, no matter what basis of absorption is selected. It is the relative share of overhead
costs borne by individual products and jobs which is affected.
Marginal Costing:
Marginal cost is the cost of one unit of a product/service which could be avoided if that unit were not
produced/provided.
Contribution is the difference between sales revenue and variable (marginal) cost of sales.
Marginal costing is an alternative to absorption costing. Only variable costs (marginal costs) are
charged as a cost of sales. Fixed costs are treated as period costs and are charged in full against
the profit of the period in which they are incurred.
x In marginal costing, closing inventories are valued at marginal (variable) production cost whereas,
in absorption costing, inventories are valued at their full production cost which includes absorbed
fixed production overhead.
x If the opening and closing inventory levels differ, the profit reported for the accounting period
under the two methods of cost accumulation will therefore be different.
Lectures: sta.saudtariq.com/Course/Detail/4885 1 Sir Saud Tariq (CAF 3, CAF 6, CFAP 3, CFAP 4, MSA 2)
6.0 Marginal and Absorption Costing SAUD TARIQ
ST Academy
x But in the long run, total profit for a company will be the same whichever is used because, in the
long run, total costs will be the same by either method of accounting. Different accounting
conventions merely affect the profit of individual periods.
Under/ Over Absorbed

Under-/over-absorbed overhead occurs when overheads incurred do not equal overheads
absorbed.
The rate of overhead absorption is based on estimates (of both numerator and denominator) and
it is quite likely that either one or both of the estimates will not agree with what actually occurs.
Actual overheads incurred will probably be either greater than or less than overheads absorbed
into the cost of production, and so it is almost inevitable that at the end of the accounting year
there will have been an over absorption or under absorption of the overhead actually incurred.
• Over absorption means that the overheads charged to the cost of sales are greater than the
overheads actually incurred.
• Under absorption means that insufficient overheads have been included in the cost of sales.
Suppose that the budgeted overhead in a production department is $80,000 and the budgeted
activity is 40,000 direct labour hours, the overhead recovery rate (using a direct labour hour basis)
would be $2 per direct labour hour. Actual overheads in the period are, say $84,000 and 45,000
direct labour hours are worked.
$
Overheadincurred(actual) 84,000
Overheadabsorbed(45,000x$2) 90,000
Over-absorptionofoverhead 6,000
In this example, the cost of production has been charged with $6,000 more than was actually
spent and so the cost that is recorded will be too high. The over-absorbed overhead will be an
adjustment to the profit and loss account at the end of the accounting period to reconcile the
overheads charged to the actual overhead.
Example:
Elsewhere has a budgeted production overhead of $180,000 and a budgeted activity of 45,000
machine hours.
Required: Calculate the under-/over-absorbed overhead, and note the reasons for the under-
/over-absorption in the following circumstances.
a) Actual overheads cost $170,000 and 45,000 machine hours were worked.
b) Actual overheads cost $180,000 and 40,000 machine hours were worked.
c) Actual overheads cost $170,000 and 40,000 machine hours were worked.
ST Academy
Profit Statement with Absorption Costing
Rs 000 Rs 000
Sales (Sales Units x Selling Price) XXX
Less: Cost of Goods Sold:
(Opening Finished Goods units x TC per
Opening Stock unit) XXX
Total Production
Cost (Production Units x TC per unit) XXX
(Closing Finished Goods units x TC per
Less: Closing Stock unit) (XXX)
Standard Cost Goods Sold XXX
Add/Less: Under/ (Over) Absorbed XXX/(XXX) XXX
Gross Profit XXX
Less: Expenses
Variable Selling & Administration Expenses XXX
Fixed Selling & Administration Expenses XXX (XXX)
Net Profit under Absorption Costing XXX
(*TC = Total Production Cost per Unit)
Profit Statement with Marginal Costing

Rs 000 Rs 000
Sales (Sales Units x Selling Price) XXX
Less: Variable Cost of Goods Sold:
(Opening Finished Goods units x VC per
Opening Stock unit) XXX
Total Production
Cost (Production Units x VC per unit) XXX
(Closing Finished Goods units x VC per
Less: Closing Stock unit) (XXX) (XXX)
Gross Contribution XXX
Less: Variable Selling & Administration Expenses (XXX)
Net Contribution XXX
Less: Fixed Costs
Fixed Production Costs (Actual) XXX
Fixed Selling & Administration Expenses XXX (XXX)
Net Profit under Marginal Costing XXX
(*VC = Variable Production Cost per Unit)
ST Academy
Statement to reconcile Profit with Marginal Costing to Profit with Absorption Costing
Rs
000
Net Profit under Marginal Costing XXX
Add: Difference in Closing Stocks under both costings XXX
(Fixed FOH per unit (OAR) x Closing Inventory units)
Difference in Opening Stocks under both (XXX
Less: costings (Production Units x VC per unit) )
(Fixed FOH per unit (OAR) x Closing (Closing Finished Goods units x VC
Inventory units) per unit)
Net Profit under Absorption Costing XXX
ST Academy
Q1) Pakistan Ltd has the following data relating to its operation for August, September and October:
August September October
Production (units) 10,000 12,000 8,500
Sales (units) 9,000 12,500 8,600
Costs:
Variable Production Costs Rs.30,000 Rs.36,000 Rs.25,500
Fixed Production Costs Rs.12,000 Rs.12,000 Rs.12,000
Variable Selling Costs Rs.6,750 Rs. 9,375 Rs.6,450
Fixed Selling Costs Rs.8,000 Rs.8,000 Rs.8,000
Sales Revenue Rs.63,000 Rs.87,500 Rs. 60,200
The normal level of production is 10,000 units. There was no opening inventory as at 1st August
Required: Prepare profit and loss statement by absorption & marginal costing and Reconcile the Profit.
Q2) Spring 2014 Q4
ST Academy
HW: Q3) Spring 2012 Q7b)
HW Q4) Spring 2009 Q4
ST Academy
Q5) Autumn 2010 Q4
ST Academy
Q6A) Autumn 2020 Q3
ST Academy
HW: Q6B) Spring 2022 Q8
ST Academy
Solutions – Marginal and Absorption Costing
Q2) Spring 2014 Q4
HW: Q3) Spring 2012 Q7b)
ST Academy
HW Q4) Spring 2009 Q4
ST Academy
Q5) Autumn 2010 Q4
ST Academy
Q6A) Autumn 2020 Q3
ST Academy
Q6B) Spring 2022 Q8 - Kenya Ltd.

Marginal & Absorption Costing ST Academy With Solution

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Marginal & Absorption Costing ST Academy With Solution

Uploaded by

Copyright:

Available Formats

6.

0 Marginal and Absorption Costing SAUD TARIQ

Absorption Costing Marginal Costing

Under/ Over Absorbed

(*TC = Total Production Cost per Unit)

Profit Statement with Marginal Costing

(*VC = Variable Production Cost per Unit)

Q2) Spring 2014 Q4

HW Q4) Spring 2009 Q4

HW: Q3) Spring 2012 Q7b)

You might also like