Absorption and Marginal Costing - Worked Examples PDF

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Absorption vs Marginal Costing Example 1 This example comes from Drury £ 10 6 300,000 100,000

Unit selling price Unit variable cost Fixed manufacturing cost per period Non-manufacturing costs per period

The company makes one product. Budgeted activity is for 150,000 items to be made each period. There were no opening inventories at the start of Period 1, and all production is finished within each period. Assume actual manufacturing fixed costs are £300,000 for each period. Here is a schedule of production and sales for each period 1-6 inclusive. Period Sales (000) Made (000)

1 150 150

2 120 150

3 180 150

4 150 150

5 140 170

6 160 140

Prepare marginal and absorption costing statements for each period 1-6 inclusive. Marginal costing statements Product cost = variable cost only, ie £6 each. Period

1 £000 Sales 1,500 Opening Inv’y Nil Production Cost 900 Less closing inv’y Nil Marginal COS 900 CONTRIBUTION 600 Less Fx’d pdct’n cost (300) Non manuf. FC (100) NET PROFIT 200

2 £000 1,200 Nil 900 (180) 720 480 (300) (100) 80

3 £000 1,800 180 900 Nil 1,080 720 (300) (100) 320

4 £000 1,500 Nil 900 Nil 900 600 (300) (100) 200

5 £000 1,400 Nil 1,020 (180) 840 560 (300) (100) 160

6 £000 1,600 180 840 (60) 960 640 (300) (100) 240

Absorption costing statements Product cost = variable cost plus (£300,000/150,000) ie £2 manufacturing fixed overhead; so it works out at £8 each. Period

1 £000 Sales 1,500 Opening inv’y Nil Productn Cost 1,200 Less clo. Inv’y Nil (Over)/under Recovery MFC Nil Cost of Sales 1,200 Gross profit 300 Non manuf. FC (100) Net profit 200

2 £000 1,200 Nil 1,200 (240)

3 £000 1,800 240 1,200 Nil

4 £000 1,500 Nil 1,200 Nil

5 £000 1,400 Nil 1,360 (240)

6 £000 1,600 240 1,120 (80)

Nil 960 240 (100) 140

Nil 1,440 360 (100) 260

Nil 1,200 300 (100) 200

(40) 1,080 320 (100) 220

20 1,300 300 (100) 200

A business with seasonal sales A firm makes high-quality deckchairs, which sell for £50 each. Production proceeds evenly throughout the year, but most sales take place in summer (period 4). Here is a schedule of the firm’s production and sale pattern. Period Production Sales

1 500 100

2 500 100

3 500 300

4 500 1,500

Sales price is £50 each, and variable costs of manufacture are £25 each. Fixed overheads are £20,000 per annum. There are no other costs of production. Prepare absorption and marginal profit statements (Note; cost of production in absorption costing is £25 + (£20,000/2,000) = £35 each. Cost of production in marginal costing is £25 each. Assume actual fixed overhead is equal to budget, and that production proceeded according to the schedule above.

Marginal costing statement Period 1 2 3 £ £ £ Sales 5,000 5,000 15,000 Opening inventory Nil 10,000 20,000 Marginal costs of prodct’n 12,500 12,500 12,500 Less closing inventory (10,000) (20,000) (25,000) Marginal cost of sales 2,500 2,500 7,500 Contribution 2,500 2,500 7,500 Fixed cost (5,000) (5,000) (5,000) Profit/(Loss) (2,500) (2,500) 2,500

4 £ 75,000 25,000 12,500 NIL 37,500 37,500 (5,000) 32,500

Profits total £30,000 for the year. Period Sales Opening inventory Cost of production Less closing inventory Cost of sales Profit

Absorption costing statement 1 2 3 £ £ £ 5,000 5,000 15,000 Nil 14,000 28,000 17,500 17,500 17,500 14,000 28,000 35,000 3,500 3,500 10,500 1,500 1,500 4,500

4 £ 75,000 25,000 17,500 Nil 52,500 22,500

Again, profits total £30,000 for the year.

Example 2 This example is adapted from Drury (similar to IM7.3) The following information relates to periods 1-4 inclusive £ 30 55 6,000

Variable cost per unit Selling price per unit Fixed costs per period

Normal activity is 500 units per quarter and production and sales data for the first four quarters are as follows. There was no opening inventory in period 1. Period Sales Production Required

1 500 500

2 400 500

3 500 450

4 450 550

Prepare marginal and absorption costing statements for each of periods 14 inclusive. SOLUTION For absorption costing, we absorb MFO into products at the rate of £6,000/500 = £12 per item, giving total product cost £30 + £12 = £42. There is no under or over absorption in Periods 1 and 2, but in Period 3, not enough fixed overheads have been charged to production. So we have to charge an under-absorption of £12 x 50 = £600. Likewise in Period 4, we have an over-absorption of 12 x 50 = £600. Period 3 opening inventory is 100 units. We made another 450 units, and sold 500 units, giving closing inventory of 50 units. Period 4 opening inventory is 50 units. We made 550 units, but only sold 450 units, so Period 4 closing inventory is 150 units ABSORPTION COSTING Period 1 2 3 4 Sales 27,500 22,000 27,500 24,750 Opening Inventory Nil Nil 4,200 2,100 Cost of production 21,000 21,000 18,900 23,100 21,000 21,000 23,100 25,200 Closing inventory Nil 4,200 2,100 6,300 (Over)/under absorption Nil Nil 600 (600) Cost of goods sold 21,000 16,800 21,600 18,300 Net profit 6,500 5,200 5,900 6,450

MARGINAL COSTING Period Sales Opening Inventory Cost of production Closing inventory Marginal Cost of goods sold Contribution Fixed manufacturing overheads Net profit

1 27,500 Nil 15,000 15,000 Nil 15,000 12,500 6,000

2 22,000 Nil 15,000 15,000 3,000 12,000 10,000 6,000

3 27,500 3,000 13,500 16,500 1,500 15,000 12,500 6,000

4 24,750 1,500 16,500 18,000 4,500 13,500 11,250 6,000

6,500

4,000

6,500

5,250...