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Absorption and marginal costing
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Def initionAbsorption costing
Marginal costing
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Marginal costingIt is a costing syst em which tr eats only th e
variabl e manu f acturing costs as productcosts. Th e f ixed manu f acturing ov erheadsar e r egard ed as p eriod cost
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CostManu f acturing cost Non-manu f acturing cost
Dir ectMaterials
Dir ectLabour
Overheads
Finish ed goods Cost o f goods sold
Period cost
Prof it and loss account
Absorption Costing
CostManu f acturing cost Non-manu f acturing cost
Dir ectMaterials
Dir ectLabour
Variabl e Overheads
Finish ed goodsCost o f goods sold
Period cost
Prof it and loss account
Marginal Costing
Fixedoverhead
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Todays Obj ectivesYesterday w e look ed at absorption and
marginal costingToday w e will look at th e pr esentation o f incom e statement using both absorptionand marginal costing.We will also look at th eor etical di ffe r ences
between marginal and absorption costing.
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Pr esentation o f costs on incom e statement
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Trading and pro f it ans loss account
Absorption costing Marginal costing $ $
Sales X Sal es XLess: Cost o f goods sold X L ess: Variabl e cost o f
Goods sold XGross pro f it X Product contribution margin X
Less: Exp enses Less: variabl e non- manu f acturingSelling expenses X expensesAdmin. expenses X Variabl e selling expenses XOther expenses X X Variabl e admin. expenses X
Other variabl e expenses XTotal contribution expenses X
Less: Exp ensesFixed selling expenses XFixed admin. expenses XOther f ixed expenses X
Net Pro f it X N et Pro f it X
Variabl e and f ixed manu f acturing
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Exampl e
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A company start ed its busin ess in 2005. The f ollowing in f ormationWas availabl e f or January to March 2005 f or th e company that produc edA singl e product:
$Selling pric e pr e unit 100Dir ect mat erials p er unit 20Dir ect Labour p er unit 10Fixed f actory ov erhead per month 30000Variabl e f actory ov erhead per unit 5Fixed selling ov erheads 1000Variabl e selling ov erheads p er unit 4
Budgeted activity was expected to b e 1000 units each monthProduction and sal es f or each month w er e as f ollows:
Jan F e b MarchUnit sold 1000 800 1100Unit produc ed 1000 1 300 900
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Absorption costing
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January F e bruary March
$ $ $Sales 100000 80000 110000Less: cost o f good sold ($65) 65000 52000 71500
28000 38500Adjustm ent f or Ov er-/(und er )Absorption o f f actory ov erhead 9000 ( 3000 )Gross pro f it 35000 37000 355 00Less: Exp enses
Fixed selling overheads 1000 1000 1000Variabl e selling overheads 4000 3200 4400
Net pro f it 30000 32800 30100
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Marginal costing
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Wk1:Standard fixed overhead rate
= Budgeted total fixed factory overheadsBudgeted number of units produced
= $300001000 units
= $30 units
Wk 2:P roduction cost per unit under absorption costing :
$
Direct materials 20Direct labour 10Fixed factory overhead absorbed 30Variable factory overheads 5
65Bac k
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Wk 3:(U nder-)/Over-absorption of fixed factory overheads :
J anuary February March$ $ $
Fixed overhead 30000 39000 27000Fixed overheads incurred 30000 30000 30000
0 9000 (3000)
1000*$30 1300*$30 900*$30
Wk 4:
Variable production cost per unit under marginal costing :$Direct materials 20Direct labour 10Variable factory overhead 5
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No fixed factory overhead
Bac k
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Diffe r ence between absorptionand marginal costing
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Absorption costing Marginal costing
Tr eatment f or f ixedmanu f acturingoverheads
Fixedmanu f acturingoverheads ar e tr eated as product
costing . It is believed that products cannot b e produc ed without
the r esourc es provid ed by f ixedmanu f acturingoverheads
Fixed manu f acturingoverhead ar e tr eatedas period costs . It is
believed that only th e
variabl e costs ar e r elevant to d ecision-making.Fixed manu f acturingoverheads will b e incurr ed r egardl essther e is production or not
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Absorption costing Marginal costing
Valu e of closing stock High value of closing stock will b e
obtain ed as som e f actory ov erheads
ar e includ ed as product costs andcarri ed f orward asclosing stock
Low er valu e of closing stock thatinclud ed the variabl e cost only
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Absorption costing Marginal costing
R e port ed pro f it If the production = Sal es, AC pro f it = M C Prof it
If Production > Sal es, AC pro f it > M C pro f itAs som e f actory ov erhead will b e defe rr ed as
product costs und er the absorption costing
If Production < Sal es, AC pro f it < M C pro f it
As th e pr eviously d efe rr ed f actory ov erheadwill b e r eleased and charg ed as cost o f goodssold
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Argum ent f or absorption costing
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Complianc e with th e generally acc e ptedaccounting principl es
Importanc e of f ixed overheads f or productionAvoidanc e of f ictitious pro f it or loss
During th e period o f high sal es, th e production issmall than th e sales, a small er numb er of f ixed
manu f acturing ov erheads ar e charg ed and a high er net pro f it will b e obtain ed und er marginal costingAbsorption costing is b etter in avoiding th e f luctuation o f pro f it being r e port ed in marginalcosting
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Argum ents f or marginal costing
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Mor e r elevanc e to decision-makingAvoidanc e of pro f it manipulation
Marginal costing can avoid pro f it manipulation byadjusting th e stock l evel
Consid eration giv en to f ixed costIn f act, marginal costing do es not ignor e f ixed costs
in setting th e selling pric e. On th e contrary, it provid es usef ul in f ormation f or br eak-even analysisthat indicat es whether f ixed costs can b e conv ertedwith th e chang e in sal es volum e
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Calculat e and explain th e conc e pt o f equival ent unitAbsorption proc ess cost b etween work r emaining in proc ess and trans fers out o f a
proc ess using w eighted av erage and FIFOmethodsPr e par e process accounts in situationswher e work r emains incompl ete and wh er e
losses and gain at di ffe r ent stag es. 27
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THE BASIC PRO CESS OFPRO CESS COSTIN G
Proc ess costing is a costing m ethod us edwher e it is not possibl e to identif y se parat e units o f production, or jobs usually b ecause of continu es natur e of the production
proc ess involv ed.
Exampl es. Oil r ef ining, f ood and drinks,chemical and pap er.
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Featur es of proc ess costingThe output o f one process becomes the input o f the other until th e f inish ed productis mad e in th e f inal proc ess.The continu es natur e of production m eansthat th er e will usually b e closing work in
progr ess which must b e valued.Ther e ar e of ten loss es in th e process du e tospoilag e, wast e, evaporation etc
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Proc ess accountsWher e a series of se parat e processes isr equir ed to manu f actur e the f inish ed
product, th e output o f one proc ess become the input to th e next until th e f inal output ismade in th e f inal proc ess. I f two proc esses
ar e r equir ed the accounts will look lik e the one below.
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Proc ess accounts exampl eProc ess 1 accounts
units $ units $
Dir ect mat erials 1000 50,000 output to proc ess 2 1000 90000Dir ect labour 20,000Production ov erhead 20,000
1000 90,000 1000 90000Process 2
Units $ units $Materials f rom proc ess 1 1000 90000 Output f inish ed 1000 1 50000Added mat erials 30000Dir ect labour 1 5000
Production ov erhead 15000 32
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Fram ework f or dealing with proc ess costing
Ste p 1. d etermin e the output and loss es
Ste p 2 Calculat e cost p er unit o f output,losses and WIPSte p 3. calculat e total cost o f output, loss esand WIPSte p 4. compl ete accounts
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Loss es in proc ess costing Normal loss es Loss expected during th e proc ess. It is not giv en a costAbnormal loss es-Extra loss r esulting wh enactual loss is gr eater than normal or expected loss and is giv en a costAbnormal gain- Is th e gain r esulting wh enactual loss is l ess than th e normal or expected loss and is giv en a n egativ e cost.
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Exampl e of abnormal loss es andgains
Suppos e that input is 1000 units at a cost o f $4500. Normal loss is 10% and th er e ar e noopening or closing stock. De termin e the accounting entries f or th e cost o f outputand cost o f the loss i f the actual output
wer e as f ollows(a) 860 units( so actual loss is 1 40 units )(b)920 units (so actual loss is 80 units )
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Output is 860 units solutionSte p 1 De termin e output and loss es
unitsActual loss 1 40
Normal loss 10%o f 1000 100
Abnormal loss 40
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Ste p 2.calculat e cost p er unit o f output andlosses
The cost p er unit o f output and cost p er unit o f abnormal loss es ar e based on expectedoutput.
Cost incurr ed/Exp ected output=$4500/900=$ 5 per unit
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Ste p 3. calculat e total cost o f output andlosses
Normal loss is not assign ed any cost$
Cost o f output ( 850*$5) 43 00 Normal loss 0Abnormal loss( 40*$5) 200
4500 38
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Ste p 4 compl ete the accountsPRO CESS A CCC OUNTS
units $ units $
Cost incurr ed 1000 4500 normal loss 100 0output 860 (*$ 5) 4300
abnormal loss 40 (*$ 5) 200
1000 4500 1000
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Exercise Now compl ete f or 920 units
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QuestionShiny Inc has two proc esses Y and Z .Ther e is an expected loss o f 5% o f input in
proc ess Y and 7% o f input in proc ess Z.Activity during a f our w eek period is asf ollows
Y ZMaterials input(kg ) 20000 28000Output(kg ) 18500 26100Is th er e an abnormal gain or abnormal loss f or each
proc ess? 41
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SolutionY Z
Input(kg ) 20000 28000
Normal loss(kg ) 1000 1 960Expected output 1 9000 26040Actual output 1 8500 26100Abnormal loss/gain 500(loss ) 60(gain )
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