CLASS EXERCISE 2

A company commenced business on 1 February making one product only, the cost card
of which is as follows:

$
Direct labour 5
Direct material 8
Variable production overhead 2
Fixed production overhead 5
––
Standard production cost 20
––

The fixed production overhead figure has been calculated on the basis of a budgeted
normal output of 36,000 units per annum. The fixed production overhead incurred in
February was $15,000 each month.

Selling, distribution and administration expenses are:

Fixed $10,000 per month

Variable 15% of the sales value

The selling price per unit is $50 and the number of units produced and sold were:

March (units)
Production 2,000
Sales 1,500

1. Prepare the absorption costing and marginal costing income statements for
February.
2. Reconcile the profit for February

You should watch the following Video which has a worked out example with
explanations before doing the homework

https://www.youtube.com/watch?v=ZGPNuFWPMyc
Suggested Solution:

Workings:

(1) Unit cost Absorption Marginal

N$ N$
Direct material 5 5
Direct Labour 8 8
Variable production O/H 2 2
Fixed production O/H 5 -
Total production unit cost 20 15

(2.) Overhead absorption:

OAR/POR/ORR = Budgeted Overheads N$15 000 = N$ 5 per unit

Budgeted units (36000/12) = 3000

Absorbed overheads = $5 x 2000 = $10 000

Actual =$15 000

Under-Absorbed overhead = $5000 add to cost of sales

(3.) Closing inventory valuation:

NB!!The moment you have opening inventory the production units

costs has changed, the use either FIFO or Weighted Average method

Production units less sales = 2000-1500 = 500

Absorption costing method = 500 x 20 =$10 000

Marginal costing method = 500 x 15 = $7 500

Statement of Profit or Loss and Other Comprehensive Income – Feb 2020

Absorption costing method $ $

Sales 75,000
Less Cost of sales: (valued at full production cost)
Opening inventory –
Variable cost of production (2,000 × $15) 30,000
Fixed overhead absorbed (2,000 × $5) 10,000
Less Closing inventory (500 × $20) (10,000)
––––––
(30,000)
–––––––
45,000
(Under) / over-absorption (W2) (5,000)
–––––––
Gross profit 40,000
Less Non-Production Costs (W4) (21,250)
–––––––
Profit / loss 18,750
–––––––

(W2)

$
Feb
Overheads absorbed (2,000 × $5) 10,000
Overheads incurred 15,000
Under-absorption on overheads 5,000
Non-production costs (W4)
Fixed = 10,000
Variable = 15% × $75,000 = $11,250
Total = $(10,000 + 11,250) = $21,250
Marginal Costing Method

$ $
Sales 75,000
Less Cost of sales: (marginal production costs only)
Opening inventory –
Variable cost of production (2,000 × $15) 30,000
less Closing inventory (500 × $15) (7,500)
–––––– (22,500)
–––––––
52,500
Less other variable costs (15% × $75,000) (11,250)
–––––––
Contribution 41,250
Less Fixed costs (actually incurred) $(15,000 + 10,000) (25,000)
–––––––
Profit / loss 16,250
_______

Profit reconciliation: N$

Profit as per Marginal costing method 16 250

Add: Increase in inventory

(Opening units less closing units x OAR = 0 – 500 x $5) 2 500

Profit as per Absorption costing method 18 750

Class question
Cost 201 Limited manufactures and sells a certain product. The following costs were incurred
during January 2020:
Total cost: N$
Direct material cost 51 000
Fixed manufacturing overhead 128 000
Fixed marketing cost 40 000
Fixed administration cost 25 000
Variable administration cost 32 000

Cost per unit: N$

Direct labour cost 4
Variable manufacturing Overhead 2.2
Variable marketing cost 1.5
Sales price 25

Cost 201 Ltd use machine hours to allocate fixed manufacturing

overheads. The absorption rate is N$5 per machine hour.
It takes 1.5 machine hours to produce one product.
On 1 January 2020 there were 5 000 products in opening inventory.
During January 2020, Cost 201 Limited produced 17 000 products and the closing
inventory on 31 January 2020 was 6 000 products.

Required:

1. Compile a statement of profit or loss according to margin and full costing methods,
2. Reconcile the difference in profit between the two methods.
Homework

Etuna Ltd manufactures ice cones. On 1 December 2019, Etuna had 410 ice cones in
inventory. It produced another 1 710 ice cones during December and there were 120 ice
cones in the storeroom on 31 December. The following actual information is available for
December 2019.

Direct material per ice cone N$4.35

Direct labour per ice cone N$2.00
Sales commission 0.85%
Fixed production overheads N$15 000
Fixed administrative overheads N$14 000
Variable production overheads N$1.85
Sales price per ice cone N$38.62

The cost of the opening inventory is the same as that for December except for direct
material cost, which decreased by 0.9% per ice cone during December. The budgeted fixed
production overheads for the year is N$45 600 and it is based on a budgeted annual
machine hours of 5700. Overheads are allocated according to the number of machine
hours and it takes 15 minutes to produce one ice cone. All manufacturing variances are
written off to cost of goods manufactured in the period in which they incurred.

Required:

1. Compile a Statement of profit or loss according to variable and absorption costing

methods, assuming that the firm uses both FIFO and CWA inventory valuation method.
2. Reconcile the difference in profit between the two methods.