CHAPTER 5: Marginal and absorption costing

• Marginal and absorption costing are two different ways of valuing the cost of goods sold and finish goods in inventory which can affect the profit charged to SOPL.

  
  

  • Period cost = cost charged in full to SOPL in period they incurred.
  • Product cost =charged to individual products and matched against the sales revenue they generate.
• Main difference between marginal costing and absorption costing is the treatment of the fixed production cost.

  
• Marginal costing = cost of a product is the additional cost incurred in producing one additional unit. Include the total of the variable costs, including direct materials, direct labour, direct expenses and variable overheads.

  
  

  Fixed overheads are not included bc it doesn't increase when one additional unit is made. Treated as a period cost and deducted in SOPL.
• Remember, non-production costs are NEVER included in inventory value. ALWAYS PERIOD COST!
• To understand marginal costing, we must understand the concept of contribution.

  
  

  CONTRIBUTION = SALES VALUE – VARIABLE COSTS

  
  

  Contribution is so called because it literally does contribute towards fixed costs and profit. Once the contribution from a product or service has been calculated, the fixed costs associated with the product or service can be deducted to determine the profit for the period.
• Contribution can be used to calculate profit:

  
  

  Total contribution = Contribution per unit × Sales volume

  
  

  Profit = Total contribution – Fixed costs
• If the selling price of a product is $150 and the profit margin is 20%, which one of the following statements is true?

  
  

  A. Mark‐up is 20%

  B. Mark‐up is 25%

  C. Mark‐up is 33.33%

  D. Mark‐up is impossible to determine without knowing unit cos

  ANSWER = B

  (P68, Q61)
• A company has just completed its first year of trading. The following information has been collected from the accounting records.

  
  

  Variable production cost per unit $45.00

  Variable selling and administration cost per unit $20.00

  Fixed production costs $250,000

  Fixed selling and administration costs $25,000

  Production and sales were 5,000 units.

  The selling price was $220 per unit throughout the year.

  
  

  Calculate the profit using marginal costing.

  
  

  ANSWER = $ 500,000
• Consider a product with a variable cost per unit of $26 and selling price of $42. Fixed costs for the period are $12,000.

  
  

  What is the contribution per unit for the product?

  
  

  If 1,000 units are sold, what is the total contribution?

  ANSWERS:

  
  

  Contribution per unit = $ 16

  
  

  Total contribution if 1000 units sold = $ 16,000
• An engineering company is preparing a price for a job. Production overhead is absorbed at the rate of $8.50 per machine hour. In order to allow for non‐production overhead costs and profit, a mark‐up of 60% of prime cost is added to the production cost.

  
  

  The following information is available for the job:

  Direct materials $10,650

  Direct labour $3,260

  Machine hours 140

  Using job costing, the price to be charged for the job is $_

  ANSWER = $ 23,446

  (P68, Q63)
• Absorption costing = build up a FULL product cost, including direct costs and a proportion of production overhead costs.

  
  

  When we use absorption costing, the FIXED production overhead is added to the cost of each unit, i.e. it is treated as a product cost rather than a period cost
• Differences between marginal and adsorption costing:

  • Marginal costing is based on classifying costs by behavior, in other words, whether a cost is variable or fixed
  • Absorption costing focuses on whether a cost is direct or indirect by nature

  
  

  Marginal and absorption costing differ in their treatment of fixed production overheads.
• Extracts from the budget of ABC for the six months to 31 December are given below:

  Sales 55,800

  Purchases 38,000

  Closing inventory finished goods 7,500

  Opening inventory finished goods 5,500

  The profit mark‐up, as a percentage of the cost of sales (to the nearest whole number) is _ %

  ANSWER = 55 %

  (P69,Q66)