FA1334 Management Accounting

CHAPTER 8: MARGINAL COSTING AND ABSORPTION COSTING

Part 1: Definition

Marginal costing is defined as the accounting system in which variable production costs are
charged to cost units and fixed costs of the period are written off in full against the contribution.
It has special value in decision making.

Absorption costing is defined as the accounting system in which all production overheads are
absorbed into production. The overheads contain items which are fixed in nature (those which
do not change when the level of activity changes) and items known as variable (those which
vary more or less directly with the activity changes).

Part 2: Format

(1) Marginal Costing (classify costs by “behavior”)

RM
Sales XXX
(-) Variable production cost Cost of Sales (XX)
(-) Variable non production cost (XX) Variable cost
Contribution XXX
(-) Fixed production cost (XX)
(-) Fixed non production cost (XX) Fixed cost
Net profit XXX

Under marginal costing,

• Product cost => variable production cost
• Period cost => fixed production cost, variable non production cost and fixed non
production cost

(2) Absorption Costing (classify costs by “element/function”)

RM
Sales XXX
(-) Variable production cost (XX) Production
Cost of Sales cost
(-) Fixed production cost (XX)
Unadjusted gross profit XXX
Over/(under) absorbed fixed production overheads X/(X)
Adjusted gross profit XXX
(-) Variable non production cost (XX) Non
(-) Fixed non production cost (XX) production
Net profit XXX cost

Under absorption costing,

• Product cost => variable production cost and fixed production cost
• Period cost => variable non production cost and fixed non production cost

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Example 1
Stock, production and sales data for ABC Sdn Bhd are given below:
Period 1 Period 2
Units Units
Production 70,000 55,000
Sales 55,000 65,000
Opening stock 1,000 16,000

The company has a single product, for which the financial data, based on a normal activity
level of 55,000 units per period are as follows:
RM
Direct materials 2.50
Direct labours 1.50
Variable production overheads 3.00
Fixed production overheads 2.00
Cost per unit 9.00

Administrative overheads are fixed at RM100,000 per period.

Variable selling overhead is RM1 per unit and fixed selling overhead is RM30,000 per period.

The selling price is RM18 per unit.

Required:

Based on the information above, prepare income statements based on:

(i) marginal costing principle
(ii) absorption costing principle

Answer
(W1) Quantity
Period 1 Period 2
(units) (units)
Opening stock 1,000 16,000
(+) Production 70,000 55,000
(-) Sales (55,000) (65,000)
Closing stock 16,000 6,000

(W2) Variable production cost per unit

RM
Direct materials 2.50
Direct labours 1.50
Variable production overheads 3.00
7.00

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(W3) Fixed production overheads per unit = Fixed production overhead

Normal quantity

RM2.00 = Fixed production overhead

55,000 units
Fixed production overheads = 55,000 units × RM2.00
= RM110,000

(W4) Cost per unit

Marginal Costing Absorption Costing
(RM) (RM)
Variable production cost per unit 7.00 7.00
Fixed production overheads per unit - 2.00
7.00 9.00

(W5) Over/(Under) absorbed fixed production overheads

Period 1 (RM) Period 2 (RM)
Fixed overheads RM2.00 × 70,000 RM2.00 × 55,000
absorbed = 140,000 = 110,000
(-) Fixed production 110,000 110,000
overheads
Over/(Under) 30,000 0
absorbed

(i) Income Statement (Marginal Costing)

Period 1 Period 2
RM RM RM RM
Sales 990,000 1,170,000
(-) Cost of sales
Opening stock 7,000 112,000
Production cost 490,000 385,000
(-) Closing stock (112,000) (385,000) (42,000) (455,000)
605,000 715,000
(-) Variable non
production cost
Variable selling (55,000) (65,000)
overhead
Contribution 550,000 650,000
(-) Fixed costs
Fixed production 110,000 110,000
overheads
Fixed selling 30,000 30,000
overhead
Fixed administrative 100,000 (240,000) 100,000 (240,000)
overheads
Net profit 310,000 410,000

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(ii) Income Statement (Absorption Costing)

Period 1 Period 2
RM RM RM RM
Sales 990,000 1,170,000
(-) Cost of sales
Opening stock 9,000 144,000
Production cost 630,000 495,000
(-) Closing stock (144,000) (495,000) (54,000) (585,000)
Unadjusted gross 495,000 585,000
profit
Over/(Under) 30,000 0
absorbed fixed
production overheads
Adjusted gross 525,000 585,000
profit
(-) Non production
costs
Variable selling 55,000 65,000
overhead
Fixed selling 30,000 30,000
overhead
Fixed administrative 100,000 (185,000) 100,000 (195,000)
overheads
Net profit 340,000 390,000

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