Marginal Costing

&
Absorption Costing

AFZAL AHMED, ACA

HEAD OF ACCOUNTS
LANKABANGLA FINANCE LIMITED
 Sample Problem 5

A company makes and sells a single product. At the beginning of period 1,

there are no opening inventories of the product, for which the variable
production cost is CU4 per unit and the sales price CU6 per unit. Fixed
costs are CU2,000 per period, of which CU1,500 are fixed production
costs.
Period 1 Period 2
Sales (units) 1200 1800
Production (units) 1500 1500

Requirements:
What profit would be reported in each period and in total using the
following costing systems?
(a) Absorption costing. Assume normal output is 1,500 units per period.
(b) Marginal costing.
 Sample Problem 6

X Ltd commenced business on 1 March making one product only. Unit

cost information for the product is as follows:
CU
Variable labour 5
Variable material 8
Variable production overhead 2
Fixed production overhead 5
The fixed production overhead figure has been calculated on the basis of a
budgeted normal output of 36,000 units per annum.
You are to assume that all the budgeted fixed expenses are incurred
evenly over the year. March and April are to be taken as equal period
months.
Selling, distribution and administration expenses are as follows:
Fixed CU120,000 per annum Variable 15% of the sales value
 Sample Problem 6 cont.…

The selling price per unit is CU35 and the number of units produced and
sold was as follows:
March April
Sales (units) 1500 3000
Production (units) 2000 3200

Requirements:
1) Assuming marginal costing:
1) Value of closing inventory for each month
2) Profit for each month
2) Assuming absorption costing:
1) Value of closing inventory for each month
2) Under/over abortion of overhead each month
3) Profit for each month
 Sample Problem 7

When opening inventories were 8,500 litres and closing

inventories 6,750 litres, a firm had a profit of Tk. 62,100
using marginal costing.

Assuming that the fixed overhead absorption rate was Tk. 3

per litre, what would be the profit,usingabsorption costing?
 Sample Problem 8

Tamim& Company gathered the following information for the year ended
December 31, 2016:

Units produced 45,000

Units expected to be produced 45,000
Units sold 43,200
Direct labour (CU) 137,200
Direct materials used (CU) 126,400
Fixed selling and administrative expenses (CU) 51,000
Variable selling and administrative expenses (CU) 58,000
Fixed manufacturing overhead (CU) 83,250
Variable manufacturing overhead (CU) 73,900
Required:
a)Under absorption costing, what is the cost of the finished goods
inventory on December 31, 2016?
b)Under variable costing, what is the cost of the finished goods inventory on
December 31, 2016?
c)Why is absorption costing more widely used than variable costing?
 Why is absorption costing more widely used
than variable costing

I. It is consistent with the matching concept in which
manufacturing costs of sales are  matched with the
sales revenue. This is why financial reporting stand
ard requires  absorption costing.

II. It facilitates cost‐plus pricing strategy. In the 
long run for survival and profitability, prices
must cover fixed costs.
 Advantages of Absorption costing

(i) Fixed production costs are incurred in order to

make output; it is therefore 'fair' to charge all
output with a share of these costs.

(ii) Closing inventory values, by including a share of

fixed production overhead, will be valued on the
principle required by accounting standards
for the financial accounting valuation of
inventories for external reporting purposes.
 Advantages of absorption costing

(iii) A problem with calculating the contribution of

various products made by a company is that it may not
be clear whether the contribution earned by each
product is enough to cover fixed costs, whereas by
charging fixed overhead to a product it is possible to
ascertain whether or not it is profitable.
 Advantages of Marginal costing

(i) It is simple to operate.

(ii) There are no apportionments of fixed costs,

which are frequently done on an arbitrary basis. Many
costs, such as the managing director's salary, are
indivisible by nature.

(iii) Fixed costs will be the same regardless of the

volume of output, because they relate to a period of
time and are period costs. It makes sense, therefore, to
charge them in full as a cost to the period.
 Advantages of Marginal costing

(iv) The cost to produce an extra unit is the variable

production cost. It is realistic to value closing
inventory items at this directly attributable cost.

(v) Under or over absorption of overheads is

avoided.

(vi) Marginal costing information can be more useful

for decision making since it focuses on the variable
costs that are most likely to be altered as the result of
a decision.
 Sample Problem 9

XYZ Limited is a manufacturing company which is currently reviewing the costing

arrangement for its product A. During the first quarter of the year, they sold
50,000 units of product A at BDT 30 per unit. They produced 45,000 units of
product A during the quarter and the following information has been provided for
the quarter:
Per unit cost (BDT) Total cost (BDT)
Direct materials 7.00 315,000
Direct labour 16.00 720,000
Production OH 5.00 225,000

At the beginning of January, there was a stock of 10,000 units valued as follows:

Per unit cost (BDT) Total cost (BDT)

Direct materials 6.50 65,000
Direct labour 16.25 162,500
Production OH 5.00 50,000
 Sample Problem 9

Sales and administrative overheads for the period were as follows:

Variable BDT 55,000
Fixed BDT 50,000

It is estimated that 40% of production overheads are variable, while the remainder
are fixed.

What would be the profit using absorption costing and marginal costing?
 Sample Problem 10

A manufacturing company produces and sells a  single product. The following 
budgeted data had  been prepared for a one‐year period:
Level of Activity
100% 60%
CU ‘000 CU ‘000
Sales Revenue 14,400 8,640
Total Manufacturing Cost 10,200 7,320
Total Selling and Administrative Cost 3,000 2.520
(Variable part varies with Sales Volume)
In compiling the above budgeted data, it had  been assumed that sales volume was
equal to  the production volume. In addition, the normal  level of activity
was 100% at which it was  estimated that 60,000 units could be produced  in the
period.
 Sample Problem 10

The actual results for the period are exhibited as  follows:
 66,000 units were produced and 62,000 units  were sold.
 Unit selling price, unit variable costs and fixed  overheads are the same as budgeted.
 There was no opening inventory.

Required
a) Calculate the manufacturing overhead absorption rate.
b) Calculate the amount of fixed manufacturing overhead absorbed in 
the products.
c) Calculate the amount of fixed manufacturing overhead over‐
absorbed or under‐absorbed.
d) Prepare the operating statement under absorption costing.
e) Prepare the operating statement under marginal costing.
f) Reconcile the profits under absorption costing and marginal 
Thank you