Cardiff Metropolitan University

Full name: Vu Thu Ha

Student ID: 20217470

Module Title: MANAGEMENT ACCOUNTING

10/04/2022
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SECTION A: SELF ASSESSMENT (TO BE COMPLETED BY THE STUDENT)

In relation to each of the set assessment criteria, please identify the areas in which you
feel you have strengths and those in which you need to improve. Provide evidence to
support your self-assessment with reference to the content of your assignment.
STRENGTHS AREAS FOR IMPROVEMENT

My advantage focus on theory exercises, I have difficulty with calculation

definition questions and concrete examples.
In addition, I have the ability to filter
important information and summarize it in a
simple and receptive manner.
questions that require large amounts of
formulas and complex numbers. The
practice of solving math problems is
giving me a hard time.

I certify that this assignment is a result of my own work and that all sources have been
acknowledged:

Signed: Vu Thu Ha ____________________________ Date:

10/04/2022__________________________
SECSTION B: TUTOR FEEDBACK
(based on assignment criteria, key skills and where appropriate, reference to
professional standards)
STRENGTHS AREAS FOR IMPROVEMENT AND
TARGETS FOR FUTURE
ASSIGNMENTS

MARK/GRADE AWARDED DATE: SIGNED

ASSIGNMENT MODERATED BY: DATE

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MODERATOR’S COMMENTS:

TABLE OF CONTENT

INTRODUCTION...............................................................................................................4

TRADITIONAL ABSORPTION COSTING – ROLES AND BENEFITS IN LARGE

ENTERPRISES...................................................................................................................5

The definition of cost.......................................................................................................5

Variable costs & Fixed costs............................................................................................5
Traditional absorption costing.........................................................................................6
Some reasons why traditional absorption costing is popular and suitable for large
enterprise..........................................................................................................................6
What difficulties might be faced by smaller firms who may want to utilize absorption
costing?............................................................................................................................7

ASSIGNING COSTS – ROLES AND METHODS............................................................9

The necessary of assigning costs.....................................................................................9

Two methods to determine cost allocation.....................................................................10

Absorption statement of profit or loss........................................................................11

Marginal statement of profit or loss...........................................................................12
The main advantage of absorption costing.....................................................................12
The significant disadvantage of marginal costing..........................................................13

CONCLUSION..................................................................................................................15

REFERENCES..................................................................................................................16

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INTRODUCTION

A basic business needs to have an understanding of the company's overall profits and

losses. But to be even more successful, that company needs to clearly calculate the profit

and loss for every company's department, every division and project within the business.

According to (Group, 2017) the establishment of a cost accounting component not only

helps the company improve the accuracy of human resource planning, thereby making

appropriate decisions, but also guides the pricing of products as well as costs of

manufacturing.

The following research mentioned two common cost allocation methods used in many

companies, thus, discussed the advantages and disadvantages of the cost allocation

problem and offered some suitable solutions for the difficulties that businesses often face.

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TRADITIONAL ABSORPTION COSTING – ROLES AND BENEFITS IN

LARGE ENTERPRISES

Question 1: It said that the traditional absorption costing is commonly used but only

suitable for large enterprises. Please provide supporting arguments for the above

statement. What difficulties might be faced by smaller firms who may want to utilize

absorption costing?

Solution:

The definition of cost

There are many definitions of cost. Overall, cost is an important base on which

companies can manage their production and business (Debitoor, 2010). More

specifically, it can be understood that costs are the expression of money from the costs of

living labor (from people, labor power) and materialized labor (properties, machinery,

facilities, ...) produced during a certain period of time. To build and run a business,

executives need to accumulate a large enough amount of capital (known as costs). That

amount of capital is evenly distributed to departments, forming investment capitals.

Every company has two main fees including fixed costs and variable costs.

Variable costs & Fixed costs

Variable costs are costs that change depending on how much of products a firm

produces. Materials, packaging, labor, goods, and other variables are all intimately linked

to the product manufacturing process. Because variable costs are directly related to the

production process. As a result, the total variable cost is proportional to the total cost of
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products sold. For example, if a firm sells few items, its variable expenses account for a

small proportion of overhead expenses; on the other hand, if the company sells more

products, its revenue also significantly increases. This indicates that a part of the

company's funds were spent on total variable costs.

Fixed costs, as contrast to variable costs, are expenses that a company is required to

pay even though it is not engaged in a business. Included are fixed revenues such as rent

costs, machinery purchase, employee wages, and insurance... These expenses will not

fluctuate (increase or decrease) in response to changes in the firm's size or output at any

particular period. The only control that has a direct effect on fixed costs is when the

company reports bankruptcy.

Traditional absorption costing

Both variable and fixed costs affect absorption costing. According to (Tuovila, 2021),

traditional absorption costing, also known as "full costing", is a cost management

technique that calculates all costs associated with a production process and allocates them

to the cost of a particular product. Direct and indirect costs (fixed and variable costs),

such as direct materials, direct labor, rent, and insurance, are accounted for using this

method.

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Some reasons why traditional absorption costing is popular and suitable for large

enterprise

Firstly, traditional absorption costing has the evident benefit of being based on

universally recognized accounting principles (GAAP) is followed by IAS2 and required

by the Internal Revenue Service (IRS), satisfied the needs of the legal basis of large

companies, accepted by the competent authority (Javed, 2019).

Secondly, large companies have many departments and large scale, so the allocation

process is complicated and at the same time producing many products. Using traditional

absorption costing method helps companies to calculate the exact unit cost of each

product, because absorption costing has the benefit of measuring the cost of all resources

and raw materials required to manufacture inventory, whether variable or fixed costs

(Aydın Gersil, Cevdet Kayal, 2016). By allocating overhead expense to exactly each

product unit, thereby forming the production cost, finally calculating the exact cost of

goods sold.

In addition, using of traditional absorption costing encourages the accounting

department of large companies keep track of the overall cost allocation process, because

absorption costing considers all manufacturing costs, including both direct and fixed

expenses. From there, it is possible to track more accurately the profit and the ending

balance in the accounting period.

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What difficulties might be faced by smaller firms who may want to utilize

absorption costing?

Traditional absorption costing has numerous advantages for large organizations, but it

is not appropriate for small and midsize enterprises. The fundamental issue is that small

businesses have few production departments and assign few sectors, but the traditional

absorption costing technique demands allocation to numerous operational divisions,

leading to not maximizing the benefits of the absorption costing method.

Furthermore, most small companies specialize in single-product, small and uneven

production, often focusing on short-term decisions, so those small companies only incur

direct (or variable) costing methods. Because the direct costing method only includes

direct costs constituting product costs, optimizing product costs and labor productivity

and at the same time saving costs and time compared to traditional absorption costing.

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ASSIGNING COSTS – ROLES AND METHODS

Question 2: Assigning costs provides information to help managers improve decision

making such as product valuation, product pricing…However the outcome depends on

the way it is done. Please provide supporting arguments and give example for the above

statement.

Solution:

The necessary of assigning costs

Assigning costs has provided information to help companies make accurate and

reasonable decisions on issues such as product pricing, inventory valuation, cost of goods

sold... "Many company owners assume they have strong costing in place, but they don't,"

says by (Henao), a BDC Senior Business Advisor who specializes in financial

management and strategy. "It's quite difficult to make well-informed judgments regarding

your operations if you don't know your expenses precisely and in a timely manner." The

relationship between cost - benefit is based on the information of each cost of materials,

packaging, labor, fixed costs, variable costs, etc. to help determine the cost of products is

completer and more accurate. That is called the cost allocation method. Most businesses

have plan for the allocation of costs, but it is important to choose the appropriate method

of goods allocation based on the basis of raw materials, consumer market, cost of goods

sold.

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Two methods to determine cost allocation

There are two methods for determining cost allocation: marginal costing and

absorption costing. According to (Bragg, 2022), the major distinction between absorption

costing and marginal costing is how the two methodologies deal with fixed

manufacturing costs. Fixed manufacturing costs are not assigned to products when using

the marginal costing technique. This is in opposite to absorption costing, which involves

the goods absorbing fixed manufacturing costs. Absorption costing allocates both

variable and fixed costs to a commodity, whereas marginal costing allocates just variable

production costs to a product, with fixed production costs being regarded a recurrent

expense.

For example, calculate the profit/loss of Best choice Clothes company under both

absorption costing and marginal costing:

Selling price $28.

Cost per unit:

Table no. 1

Direct materials 10

Direct wages 7

Variable product overhead 4

Fixed production overhead 0.70

21.70

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There is a variable selling cost per unit of $0.35.

Table no. 2

Year 1 Year 2

units units

Budgeted production 13,000 13,000

Actual production 15,000 12,300

Actual sales 14,000 13,300

Actual fixed production $12,000 $12,000

overhead

Actual fixed selling costs $6,000 $6,000

There is no opening inventory. All variable cost were as per budget for the two years.

Absorption statement of profit or loss

Table no.3

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Year 1 Year 1 Year 2 Year 2

$ $ $ $
Sales $28 392,000 372,400

Less: CoS
Opening inventory 21,700
Production cost
Variable 315,000 262,500
Fixed (absorbed) 10,500 8,750
Adjustment for over/under-absorption -1,500 3,250
324,000 296,200
Less: Closing inventory -21,700
302,300 296,200
-302,300 -296,200
Gross profit 89,700 76,200
Less: Selling costs
Variable -4,900 -4,655
Fixed -6,000 -6,000
Net profit 78,800 65,545

Marginal statement of profit or loss

Table no. 4

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Year 1 Year 1 Year 2 Year 2

$ $ $ $
Sales $28 392000 372400
Less: COS
Opening inventory 21000
Production cost - variable 315000 262500
315000 283500
Less: Closing inventory -21000
294000 283500
-294000 -283500
98000 88900
Less: Variable selling costs -4,900 -4,655
Contribution 93100 84245
Less: Fixed cost
Production 12,000 12,000
Selling 6,000 6,000
18,000 18,000
-18,000 -18,000
Net profit 75100 66245

The main advantage of absorption costing

According to (Dauda, 2021), absorption costing method provides the most realistic

total cost of a product by including fixed manufacturing costs and variable costs in the

cost of the product. It makes the total cost of the product more realistic. It is clear from

absorption costing statement (table no.3) that fixed and variable costs are evenly

distributed across the units price (direct material $10 + direct wages $7 + variable

production overhead $4 = $21) then forming variable costs, fixed production overhead

($0.70) is allocated to fixed cost. Calculate the production costs of absorption costing:

Production cost = Variable and fixed cost of year 1 + variable and fixed cost of year 2

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 [15,000 x $21 (year 1) + 15,000 x $0.70 (year 1)] + [12,500 x $21 (year 2) + 12,500 x

$0.70 (year 2)]

 [$315,000 + $10,500] + [$262,500 + $8,750]

 $325,500 + $271,250

 $596,750.

Thereby helping to selling price covers all cost per units.

The significant disadvantage of marginal costing

According to (CROWNYOU, 2020) the most significant disadvantage of marginal

costing is unrealistic reporting. The marginal cost method excludes fixed overheads from

stock pricing affecting the Profit and Loss Account (specifically, production pricing takes

a loss), thereby creating a Balance Sheet unrealistic math. If it is based on variable costs

(including direct materials + direct wages + variable production overhead = $10 + $7 +

$4 = $21) of marginal costing (table no.4), production cost does not cover all costs

because it includes only variable costs (fixed costs are not included). Calculate the

production costs of marginal costing:

Production costs = Variable cost of year 1 + Variable cost of year 2

 (15,000 x $21) + (12,500 x $21)

 $315,000 + $262,500

 $577,500.

Comparing production cost based on absorption costing and marginal costing method,

I find that net profit of marginal cost is lower than net profit of absorption cost, because

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by using absorption costing method, the cost - benefit issue is fully utilized, cost per units

are fully covered, helping to assign the exact selling price (no loss). Conversely, marginal

costing method does not using cost-benefit issue, incomplete price-per-unit information

(fixed production overhead is not included) leads to inaccurate product selling prices,

resulting in losses. The costs per units are fully covered, including the fixed costs, so that

the product pricing does not suffer a loss.

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CONCLUSION

One of the most important criterions for company owners when launching a corporate

finance enterprise is to figure out how to allocate the costs. Many accounting

professionals regard absorption costing and marginal costing to be two types of cost

allocation strategies that are tough to pick due to a variety of factors, advantages and

disadvantages. Although the absorption costing approach is becoming more popular and

is being used by many large accounting departments, it is critical to comprehend and

grasp each company's strategy and business challenge in order to make the best selections

possible.

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REFERENCES

Aydın Gersil, Cevdet Kayal. (2016, May). A COMPARATIVE ANALYSIS OF NORMAL.

Retrieved from IAEME Publication:
https://iaeme.com/MasterAdmin/Journal_uploads/IJM/VOLUME_7_ISSUE_3/
IJM_07_03_009.pdf

Bragg, S. (2022, March 29). The difference between marginal costing and absorption
costing. Retrieved from AccountingTools. Inc:
https://www.accountingtools.com/articles/the-difference-between-marginal-
costing-and-absorption-costi.html

CROWNYOU. (2020, Jun 12). Advantages and Disadvantages of Marginal Costing.

Retrieved from ToughNickel.com: https://toughnickel.com/business/Advantages-
and-Disadvantages-of-Marginal-Costing

Dauda, A. (2021, October 27). The Main Advantages and Disadvantages of Absorption
Costing. Retrieved from Bizinfong:
https://www.bizinfong.com/business/advantages-and-disadvantages-of-absorption-
costing/

Debitoor. (2010). Debitoor's accounting dictionary. Retrieved from Debitoor:

https://debitoor.com/dictionary/cost

Group, N. (2017, February 14). The role of cost accounting in project management.
Retrieved from NEXTEC: https://www.nextecgroup.com/cost-accounting-role-in-
project-management/

Henao, J. (n.d.). 5 steps to understanding your costs. Retrieved from BDC:

https://www.bdc.ca/en/articles-tools/money-finance/manage-finances/
understanding-your-costs

Javed, R. (2019, January 19). Advantages and disadvantages of absorption costing.

Retrieved from Accounting For Management:
https://www.accountingformanagement.org/advantages-and-disadvantages-of-
absorption-costing/

Tuovila, A. (2021, September 19). Absorption costing. Retrieved from Investopedia:

https://www.investopedia.com/terms/a/absorptioncosting.asp

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