Marginal and Absorption Cost

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ACOF 014 Introduction to Costing Semester 2 2008/ 2009 TOPIC 7: ABSORPTION AND

MARGINAL COSTING

Outline: 1. Learning Objectives 2. Differences between absorption and variable costing 3. Impact on profit under each costing technique 1. Learning objectives a. Explaining the differences between absorption costing and marginal costing b. Explaining the impact on stock valuation & profit under each costing system c. Explaining the impact on under each costing system d. Preparing multi-period absorption and marginal costing profit statements 2. Explaining the differences between absorption costing and Marginal costing 298) Flow of Costs under Full Absorption & Marginal Costing PERIOD COST Selling and administrative expenses FULL ABSORPTION COSTING PRODUCT COSTS Fixed manufacturin g overhead Variable manufacturing overhead Direct materials and direct labour

Work in process inventory

Expenses for the period

Cost of goods sold

Closing inventories

PERIOD COST Selling and administrative

MARGINAL COSTING PRODUCT COSTS Fixed manufacturin Variable manufacturing Direct materials and 1

expenses

g overhead

overhead

direct labour

Work in process inventory

Expenses for the period

Cost of goods sold

Closing inventories

Absorption Costing = full costing - DM + DL + Marginal + fixed manufacturing OH  product cost - Non-manufacturing cost  period cost Marginal Costing (Variable/ Direct Costing) DM + DL + Marginal manufacturing OH  product cost Fixed manufacturing OH + non-manufacturing cost  period cost Which method should be used? External reporting  use absorption Costing Match costs against revenues. ** absorption costing  may have under/over recovery of fixed overheads  charged to I/S as period costs (refer Topic #4 on OH) Internal reporting  debatable  both useful in different ways The Concept of Contribution Margin MARGINAL COST = VARIABLE COST = DIRECT LABOUR + DIRECT MATERIAL + DIRECT EXPENSE + VARIABLE OVERHEADS CONTRIBUTION MARGIN = SALES – MARGINAL COST  the contribution margin (CM) is the excess of sales revenues over varibale costs  in other words, CM is the amount available to cover the fixed costs, once they are covered, any remaining amounts adds directly to the income form the operations. CM could also be expressed in total or per unit of product.

Illustration 1: Contribution Margin Income Statement Sales Variable costs RM 1,000,000 600,000

2

CM Fixed costs Income from operations

RM RM

400,000 300,00 100,000

Available to cover the FC of RM300,000.

(note: think of the fixed costs as a bucket and the CM is water filling the bucket. Once the bucket is filled, the overflow represents income from operations. Up until the point of overflow, however, the CM contributes to fixed costs (filling the bucket)).

3. Preparing multi-period absorption and marginal costing profit statements Illustration 2: The unit cost of production for a firm which produces a single product is: Direct materials 2.60 Direct labour 3.00 Variable overhead 0.40 Fixed overhead 1.00 7.00 The fixed overhead calculation is based on a budgeted level of activity of 150,000 units and budgeted manufacturing fixed overheads f RM150,000 for each quarter. The budgeted selling and administration overheads are RM100,000 per quarter (all fixed). The selling price for the product is RM10 per unit. The production and sales for each quarter were: Quarter 1 Production (units) 150,000 Sales (units) 150,000 Quarter 2 Quarter 3 170,000 140,000 150,000 140,000 160,000 160,000 Quarter 4

There was no opening stock in Quarter 1 and you should assume that actual costs were identical to estimated costs. You are required to: a) produce in columnar format, absorption and variable costing profit statements b) comment on the results for each quarter and the year as a whole

Illustration 3: Assume, for example, that on June 1, Hamilton Manufacturing Company opened a new plant in Nashville. Data for...
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