Marginal Costing

Just over a year ago Paul Norton set up a small business (Paul Norton Enterprises) to
manufacture a plug-in flash module for mobile phones. The device, called the Sunbeam,
enables mobile phones to take better photographs in low light conditions

The selling price is £24 each and the variable cost is £6 each for materials and £10
per unit for labour. Labour can be regarded as a variable cost. There are fixed costs
incurred as follows:

£ per quarter
Fixed production overheads 3,400
Fixed administration overheads 2,400
Fixed selling overheads 2,800

Note 1: With an assumed/normal output level of 1700 Sunbeams, the pre-determined

fixed production overhead absorption rate was set at £2 per unit.

Note 2: It can be assumed that actual overhead costs turned out to be the same amounts
as budgeted.

Paul’s business partner originally suggested when they started operations that
accounts should be produced each quarter. However, this was not actioned during the
first half of the year due to manufacturing problems which they both needed to focus
on. They also realised that they did not really understand what the different accounting
systems meant, in particular the difference between absorption costing and marginal
costing approaches.

They now have figures for the last two quarters of operation (Quarter 3 and Quarter
4) and would like to see statements showing gross and net profits for those two
quarters as well as values for the inventory of Sunbeams held at the end of each
quarter.

At the beginning of Quarter 3 there were 240 Sunbeams held as inventory.

Quarter 3 production was 1,800 Sunbeams with sales amounting to 1,650
units. Quarter 4 production was 2,000 units with 2,100 Sunbeams sold.

 Requirement
(a) Define absorption costing and marginal costing and explain the
difference between the two systems. (4)

(b) State which system produces the higher profit figure when inventory
levels are rising and when inventory levels are falling. (2)

(c) Produce profit statements for Quarters 3 and 4 using BOTH marginal
costing AND absorption costing approaches, showing profit figures and
inventory values. Reconcile the profit figures produced for both
quarters. (12)