Marginal and Absorption Costing

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MARGINAL AND ABSORPTION COSTING
Marginal costing is a technique in which production units are valued at marginal cost of production and fixed costs are written off as period costs.

It follows that, stocks are valued using only the variable cost of production whereas fixed costs are treated as relating to the period and must be taken off in total. Management accounting is based on marginal costing.

TERMINOLOGY USED.
Gross contribution: Is the difference between sales value and variable costs of sales. Net contribution: Is the difference between gross contribution and non-production variable costs.

Proforma /Structure of Marginal Cost Statement
Sales x
Cost of sales
Opening stock x
Production x
x
Closing stock(x)(x)
Gross contribution x Variable non-production costs – selling + distribution (x) - admin.(x)
Net contribution x
Fixed costs – non productionx
- productionx(x)
x
Net profit
Decisions are made on the basis of net contribution not net profit.

Absorption costing is a costing technique in which production units are valued at full costs of production i.e. variable production costs plus fixed production costs.

Fixed costs are absorbed in the process and they lead to over or under absorption in which case over-absorbed overheads are added to the profit while under absorbed overheads are deducted from the profit in order to arrive at the adjusted profit. Non-production costs (variable and fixed) are written off in total during the period.

NOTES:
• When actual production is greater than budgeted production, then over-absorption occurs. • When actual production is less than budgeted production, then under-absorption occurs. The amount of the over or under absorption is the product of the difference between actual and budgeted output with the fixed overhead absorption rate i.e. (Budgeted production – Actual production ) x F.O.AR. PROFORMA OF ABSORPTION PROFIT STATEMENT

Sales x
Cost of sales
Opening stock (full cost) x
Production (full cost) x
x
Closing stock (full cost)(x)
Production cost of sales xx
Over and under-absorption (x)/x xx Gross profit x
Non-production costs
Selling and distributionx
Administrationx(x)
Net profit x

Example:
A company manufactures and sells a single product at Shs.150 per unit. Production costs per unit are:-

MaterialsShs.60
LabourShs.30
Variable overhead.Shs.20.

Variable selling expenses are 5% of sales revenue.

Fixed monthly costs -Production250,000
-Selling and distribution150,000
-Administration120,000

Fixed production overheads are absorbed on the basis of normal production of 20,000 units per month i.e. Shs.12.5 per unit. Sales for the months’ of January to April were in (units) 20,000, 22,000 respectively, but production was: - 23,000, 20,000 for those months.

Required:
Marginal and absorption costing profit statements by months.

Solution:
Summary of facts:
(i)Production costs

Marginal Absorption

Materials 6060
Labour 3030
Variable overhead. 2020
Fixed production __ 12.5
Marginal unit cost 110 122.5
(ii)Production Units and Sales:
Q1Q2
Production units23,00020,000
Sales units20,00022,000
Closing stock 3,000 1,000 -
Opening stock - 3,000
Excess production 3,000 - - -

(a)MARGINAL COSTING PROFIT...
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