ABSORPTION AND MARGINAL COSTING STUDENT NOTES Accountants and managers require financial information for many different

purpos es. To help make such decisions, costs can be classified in different ways: dire ct or indirect (in relation to production product costs) fixed, variable or semi -variable (in relation to time period costs). The difference in the treatment of fixed and variable costs is often crucial in making these decisions. The way fi xed and variable costs are treated can give substantially different valuations o f stock and hence profits. Dividing costs into product costs or period costs is essential in considering cost elements in absorption and marginal costing. Produ ct costs: can be identified with a product, e.g. direct wages and direct materia ls. can be charged against revenue in the period when the products to which they relate are sold. form part of the valuation of stock of finished goods and work -inprogress. Period costs are not included in the valuations of stock. vary with production. Period costs: are those associated with time as opposed to product, e.g. annual insurance. can be charged against revenue in the period in which th ey are incurred. are usually fixed over a period of time, e.g. annual rent. ABSORPTION AND MARGINAL COSTING (H) 1

ABSORPTION AND MARGINAL COSTING Advantages of marginal costing Easy for non-accountants to understand and can be used with standard costing systems. Can be used in break-even analysis. Fixed c osts are incurred over a period of time. Such costs are not therefore directly r elated to production and hence are not included in the valuation of stock. Profi ts calculations are more realistic because they are related to the time period d uring which they arise. Fixed costs are not carried forward from one accounting period to the next. Assists when choices have to be made between alternatives, a nd contribution (selling price variable costs) is a critical consideration. Pric ing policy can be related to variable costs as fixed costs are deducted from tot al contribution. This can assist when making decisions regarding special orders. The unit cost is pre-determined. Problems arising from a variable fixed cost pe r unit are eliminated. Apportionment of overheads is required. Overhead apportio nment is frequently calculated on a subjective basis of the relationship between fixed costs and departmental activity. Under or over-absorption of overheads is avoided. (See section on under and over-absorption of overheads). The procedure s to deal with under or over-absorption of overheads takes place when the level of activity differs from the pre-planned level. Useful when a costing is require d for a specific decision that management is considering. Advantages of absorpti on (total) costing Fixed costs are incurred as a natural part of production. As absorption costing includes all relevant production costs in valuing closing sto ck a more realistic profit figure can be calculated. In marginal costing losses can occur in periods when sales are low and total fixed costs are written off. I f the goods are sold in a later period then a distortion in the profit figures m ay arise. 2 ABSORPTION AND MARGINAL COSTING (H)

ABSORPTION AND MARGINAL COSTING Absorption costing gives better information for pricing products as it includes both variable and fixed costs. Marginal costing may lead to lower prices being o ffered if the firm is operating below capacity. Customers may still expect these lower prices as demand/capacity increases. Which method should be used? As both methods have advantages and disadvantages, the precise method to use will depen d on specific circumstances and the nature of the product/business. Where the vi ability of a product is desired, marginal costing would be used. However, a firm with a long-maturing product, such as whisky, may decide absorption costing is the more appropriate method. Only one method will be used by a firm. Over and un der-absorption of overheads In the first set of examples provided in this resour ce the problem of over and under-absorption of overheads has been avoided by ass uming that the actual and normal or planned output are the same. This is an unre alistic assumption. Consider the following example. Normal/planned production le vel Normal/planned fixed overheads Actual production 8,000 units 40,000 7,500 uni ts Fixed cost per unit = 40,000/8,000 = 5 Cost charged to production = 7,500 5 = 37,500 Under-absorbed fixed cost = 40,000 37,500 = 2,500 This means that 2,500 less than t he actual fixed cost has been charged to the finished products, thus this underabsorbed overhead must be deducted from the profit calculated. ABSORPTION AND MARGINAL COSTING (H) 3

ABSORPTION AND MARGINAL COSTING Exemplar 1 Normal production equals actual production Consider the following information il lustrating the manufacture of a single product. Selling price per unit Variable cost per unit Annual fixed cost Normal production level Actual production level Sales 20 12 40,000 10,000 units 10,000 units 9,500 units The profit statement using absorption costing would appear as shown below. Profi t statement using absorption costing Sales (note 1) Less cost of sales Variable costs (Note 2) Fixed costs (Note 3) 190,000 120,000 40,000 160,000 8,000 Closing stock (Note 4) Profit Note 1 Note 2 Note 3 Note 4 Sales 9500 units 20 = 19 0,000 Variable costs 10,000 12 = 120,000 Fixed costs entered as actual figure 152,000 38,000 Closing stock (units) = 10,000 9,500 = 500 units Closing stock valued at total c ost per unit number of units Total cost per unit (TCpu) = Variable cost per unit (VCpu) + Fixed cost per unit (FCpu) Fixed cost per unit calculated on normal pr oduction level = 40,000 / 10,000 units = 4 per unit TCpu = 12 + 4 = 16 Closing stock = 500 units 16 = 8,000 4 ABSORPTION AND MARGINAL COSTING (H)

ABSORPTION AND MARGINAL COSTING Profit statement using marginal costing Sales (Note 1) Less cost of sales Variab le costs (Note 2) Closing stock (Note 5) Contribution Fixed cost Profit 190,000 120,000 6,000 114,000 76,000 40,000 36,000 Note 5 Closing stock valued at variable cost per unit number of units Closing st ock = 500 12 = 6,000 As can be seen, the treatment of fixed costs has an influence on the valuation of closing stock and the eventual profit. The following table illustrates the differences. Absorption Closing stock Profit 8,000 38,000 Marginal 6,000 36,000 ABSORPTION AND MARGINAL COSTING (H) 5

ABSORPTION AND MARGINAL COSTING Exercise 1 From the following data relating to three firms, prepare two statemen ts each to show how profit is calculated using (a) (b) Absorption costing Margin al costing. Selling price per unit Variable cost per unit Annual fixed cost Normal productio n level (units) Actual production level (units) Sales (units) Firm A 25 15 60,000 20,000 20,000 18,500 Firm B 10 4 20,000 5,000 5,000 4,200 Firm C 12 8 120,000 60,000 60,000 57,500 6 ABSORPTION AND MARGINAL COSTING (H)

ABSORPTION AND MARGINAL COSTING Exercise 1 Solution Firm A (a) Profit statement using absorption costing Sales L ess cost of sales Variable costs Fixed costs 462,500 300,000 60,000 360,000 27,000 Closing stock (Note 1) Profit 333,000 129,500 (b) Profit statement using marginal costing 462,500 Sales Less cost of sales Variable costs Closing stock (Note 2) Contribution Fixe d costs Profit 300,000 22,500 277,500 185,000 60,000 125,000

Note 1 Fixed costs/Output = 60,000/20,000 units = 3 per unit TCpu = VCpu + FCpu = 1 5 + 3 = 18 Closing stock (units) = Production Sales = 20,000 18,500 = 1,500 1,500 8 = 27,000 Note 2 Closing stock (units) VCpu = 1,500 15 = 22,500 ABSORPTION AND MARGINAL COSTING (H) 7

ABSORPTION AND MARGINAL COSTING Firm B (a) Profit statement using absorption costing Sales Less cost of sales Va riable costs Fixed costs 42,000 20,000 20,000 40,000 6,400 Closing stock (Note 1) Profit 33,600 8,400 (b) Profit statement using marginal costing 42,000 Sales Less cost of sales Variable costs Closing stock (Note 2) Contribution Fixe d costs Profit 20,000 3,200 16,800 25,200 20,000 5,200

Note 1 Fixed costs/Output = 20,000/5,000 units = 4 per unit TCpu = VCpu + FCpu = 4 + 4 = 8 Closing stock (units) = Production Sales = 5,000 4,200 = 800 800 8 = 6, ote 2 Closing stock (units) VCpu = 800 4 = 3,200 8 ABSORPTION AND MARGINAL COSTING (H)

ABSORPTION AND MARGINAL COSTING Firm C (a) Profit statement using absorption costing Sales Less cost of sales Va riable costs Fixed costs 690,000 480,000 120,000 600,000 25,000 Closing stock (Note 1) Profit 575,000 115,000 (b) Profit statement using marginal costing 690,000 Sales Less cost of sales Variable costs Closing stock (Note 2) Contribution Fixe d costs Profit 480,000 20,000 460,000 230,000 110,000

Note 1 Fixed costs/Output = 120,000/60,000 units = 2 per unit TCpu = VCpu + FCpu = 8 + 2 = 10 Closing stock (units) = Production Sales = 60,000 57,500 = 2,500 2,500 0 = 25,000 Note 2 Closing stock (units) VCpu = 2,500 8 = 20,000 ABSORPTION AND MARGINAL COSTING (H) 9

ABSORPTION AND MARGINAL COSTING Exemplar 2 Under and over-absorption of overheads OTR plc sets up as a manufacturing busine ss in Aberdeen. The selling price of its single product is 25 per unit. Direct ma terial costs are 4 per unit and the direct labour costs are 11 per unit. Annual fi xed costs are 50,000 for a normal production level of 10,000 units. The following information relates to production and sales for Year 1 and Year 2. Year 1 11,50 0 10,000 Year 2 9,500 10,500 Production (units) Sales (units) You are required to prepare statements showing the valuation of stock and the pr ofit figures for Years 1 and 2 using: (a) (b) Absorption costing Marginal costin g. 10 ABSORPTION AND MARGINAL COSTING (H)

ABSORPTION AND MARGINAL COSTING (a) Profit statement using absorption costing Year 1 250,000 Year 2 262,500 Sales (Note 1) Less cost of sales Opening stock Variable costs (Note 2) Fixed co sts (Note 3) 172,500 57,500 230,000 30,000 30,000 142,500 47,500 220,000 10,000 Closing stock (Note 4) 200,000 50,000 7,500 57,500 210,000 52,500 (2,500) 50,000 Over/(under)-absorbed (Note 5) Profit

Note 1 Sales Year 1 = 10,000 units 25 = 250,000 Year 2 = 10,500 units 25 = 262,500 ote 2 Variable costs Year 1 = 11,500 units (4 + 11) = 172,500 Year 2 = 9,500 units (4 + 11) = 142,500 Note 3 Fixed costs Fixed cost per unit = 50,000/10,000 = 5 Fixed c ost charged to production in Year 1 = 11,500 5 = 57,500 Fixed cost charged to prod uction in Year 2 = 9,500 5 = 47,500 Note 4 Closing stock Year 1 = (11,500 10,000) (4 + 11 + 5) = 30,000 Year 2 = (1,500 + 9,500 10,500) 20 = 10,000 Note 5 Over/und sorption of overheads Year 1 = 57,500 50,000 = 7,500 over-absorbed Year 2 = 50,000 4 ,500 = 2,500 under-absorbed ABSORPTION AND MARGINAL COSTING (H) 11

ABSORPTION AND MARGINAL COSTING (b) Profit statement using marginal costing Year 1 250,000 Year 2 262,500 Sales (Note 1) Less cost of sales Opening stock Variable costs (Note 2) 172,500 172,500 22,500 22,500 142,500 165,000 7,500 Closing stock (Note 6) Contribution Fixed costs Profit 150,000 100,000 50,000 50,000 157,500 105,000 50,000 55,000 Note 6 Closing stock Year 1 = 1,500 15 = 22,500 Year 2 = 500 15 = 7,500 12 ABSORPTION AND MARGINAL COSTING (H)

ABSORPTION AND MARGINAL COSTING Exercise 2 PLK plc sets up as a manufacturing business in Dundee. The selling pr ice of its single product is 30 per unit. Direct material costs are 6 per unit and the direct labour costs are 10 per unit. Annual fixed costs are 80,000 for a norm al production level of 20,000 units. The following information relates to produc tion and sales for Year 1 and Year 2. Year 1 19,000 18,000 Year 2 20,500 19,500 Production (units) Sales (units) You are required to prepare statements showing the valuation of stock and the pr ofit figures for Year 1 and Year 2 using: (a) (b) Absorption costing Marginal co sting. Exercise 3 Annie Hall plc sets up as a manufacturing business in Kirkcaldy. The selling price of her single product is 10 per unit. Direct material costs are 3 pe r unit and the direct labour costs are 2 per unit. Annual fixed costs are 100,000 for a normal production level of 50,000 units. The following information relates to production and sales for Year 1 and Year 2. Year 1 48,000 47,000 Year 2 52,0 00 52,500 Production (units) Sales (units) You are required to prepare statements showing the valuation of stock and the pr ofit figures for Year 1 and Year 2 using: (a) (b) Absorption costing Marginal co sting. ABSORPTION AND MARGINAL COSTING (H) 13

ABSORPTION AND MARGINAL COSTING Exercise 2 Solution (a) Profit statement using absorption costing Year 1 540,000 Year 2 585,000 Sales Less cost of sales Opening stock Variable costs Fixed costs 304,000 76,000 380,000 20,000 20,000 328,000 82,000 430,000 40,000 Closing stock 360,000 180,000 (4,000) 176,000 390,000 195,000 2,000 197,000 (Under)/Over-absorbed overheads Profit (b) Profit statement using marginal costing Year 1 540,000 Year 2 585,000 Sales Less cost of sales Opening stock Variable costs 304,000 304,000 16,000 16,000 328,000 344,000 32,000 Closing stock Contribution Fixed costs Profit 288,000 252,000 80,000 172,000 312,000 273,000 80,000 193,000 14 ABSORPTION AND MARGINAL COSTING (H)

ABSORPTION AND MARGINAL COSTING Exercise 3 - Solution (a) Profit statement using absorption costing Year 1 470,0 00 Year 2 525,000 Sales Less cost of sales Opening stock Variable costs Fixed costs 240,000 96,000 336,000 7,000 7,000 260,000 104,000 371,000 3,500 Closing stock 329,000 141,000 (4,000) 137,000 367,500 157,500 4,000 161,500 (Under)/Over-absorbed overheads Profit (b) Profit statement using marginal costing Year 1 470,000 Year 2 525,000 Sales Less cost of sales Opening stock Variable costs 240,000 240,000 5,000 5,000 260,000 265,000 2,500 Closing stock Contribution Fixed costs Profit 235,000 235,000 100,000 135,000 262,500 262,500 100,000 162,500 ABSORPTION AND MARGINAL COSTING (H) 15

ABSORPTION AND MARGINAL COSTING Exemplar 3 Using overhead absorption rates Thompson and Burnett are a manufacturing partner ship. During Year 1 the following information becomes available. Sales Costs Dir ect material Direct labour (12 per labour hour) Variable production overheads Fix ed production overheads Fixed selling and distribution expenses 800,000 250,000 240,000 150,000 124,000 25,000 Information regarding opening and closing stock is as follows: Direct Material 1 Jan 31 Dec 60,000 75,000 Direct Labour 36,000 48,000 Variable Production Overhead 18 ,000 35,000 Fixed Production Overhead ? ? Fixed overheads are recovered at 6 per direct labour hour. You are required to pr epare two profit statements using: (a) (b) Absorption costing Marginal costing. 16 ABSORPTION AND MARGINAL COSTING (H)

ABSORPTION AND MARGINAL COSTING (a) Profit statement for Year 1 using absorption costing 800,000 Sales Less cost of sales Opening stock (Note 1) Direct material Direct labour Va riable production overhead Fixed production overhead (Note 2) 132,000 250,000 240,000 150,000 120,000 892,000 182,000 Closing stock (Note 3) 710,000 90,000 4,000 86,000 25,000 61,000 Less under-absorbed overhead (Note 4) Fixed selling and distribution expenses Profit Note 1 Number of labour hours charged to opening stock = 36,000/12 = 3,000 Fixed overhead charged to opening stock = 3,000 6 per hour = 18,000 Valuation of stock = 60,000 + 36,000 + 18,000 + 18,000 = 132,000 Note 2 Fixed overhead charged to product ion. Number of labour hours worked = 240,000/12 = 20,000 Fixed overhead charged to production = 20,000 6 = 120,000 Note 3 Number of labour hours charged to closing stock = 48,000/12 = 4,000 Fixed overhead charged to closing stock = 4,000 6 per ho ur = 24,000 Valuation of stock = 75,000 + 48,000 + 35,000 + 24,000 = 182,000 Note 4 Un der-absorbed overhead = 124,000 120,000 = 4,000 ABSORPTION AND MARGINAL COSTING (H) 17

ABSORPTION AND MARGINAL COSTING (b) Profit statement for Year 1 using marginal costing 800,000 Sales Less cost of sales Opening stock (Note 5) Direct material Direct labour Va riable production overhead 114,000 250,000 240,000 150,000 754,000 158,000 Closing stock (Note 6) Contribution Fixed production overheads Fixed selling and distribution expenses Profit 596,000 204,000 124,000 25,000 149,000 55,000 Note 5 Valuation of stock = 60,000 + 36,000 + 18,000 = 114,000 Note 6 Valuation of s tock = 75,000 + 48,000 + 35,000 = 158,000 18 ABSORPTION AND MARGINAL COSTING (H)

ABSORPTION AND MARGINAL COSTING Exercise 4 Telfer and Burrows are a manufacturing partnership. During Year 1 the following information becomes available. Sales Costs Direct material Direct lab our (10 per labour hour) Variable production overheads Fixed production overheads Fixed selling and distribution expenses 600,000 175,000 180,000 90,000 75,000 45,000 Information regarding opening and closing stock is as follows. Direct Material 1 Jan 31 Dec 15,000 30,000 Direct Labour 18,000 24,000 Variable Production Overhead 12 ,000 20,000 Fixed Production Overhead ? ? Fixed overheads are recovered at 4 per direct labour hour. You are required to pr epare two profit statements using: (a) (b) Absorption costing Marginal costing. ABSORPTION AND MARGINAL COSTING (H) 19

ABSORPTION AND MARGINAL COSTING Exercise 4 Solution (a) Profit statement for Year 1 using absorption costing Sal es Less cost of sales Opening stock (Note 1) Direct material Direct labour Varia ble production overhead Fixed production overhead (Note 2) 600,000 52,200 175,000 180,000 90,000 72,000 569,200 83,600 Closing stock (Note 3) 485,600 114,400 (3,000) 111,400 45,000 66,400 Less under-absorbed overhead (Note 4) Fixed selling and distribution expenses Profit Note 1 Number of labour hours charged to opening stock = 18,000/10 = 1,800 Fixed o verhead charged to opening stock = 1,800 4 = 7,200 Valuation of stock = 15,000 + 18, 000 + 12,000 +7,200 = 52,200 Note 2 Fixed overhead charged to production Number of labour hours worked = 180,000/10 = 18,000 Fixed overhead charged to production = 1 8,000 4 = 72,000 Note 3 Number of labour hours charged to closing stock = 24,000/10 = 2,400 Fixed overhead charged to closing stock = 2,400 4 = 9,600 Valuation of sto ck = 30,000 + 24,000 + 20,000 + 9,600 = 83,600 Note 4 Under-absorbed overhead = 75,000 72,000 = 3,000 20 ABSORPTION AND MARGINAL COSTING (H)

ABSORPTION AND MARGINAL COSTING (b) Profit statement for Year 1 using marginal costing 600,000 Sales Less cost of sales Opening stock Direct material Direct labour Variable pr oduction overhead 45,000 175,000 180,000 90,000 490,000 74,000 Closing stock Contribution Fixed production overheads Fixed selling and distribu tion expenses Profit 416,000 184,000 75,000 45,000 120,000 64,000 ABSORPTION AND MARGINAL COSTING (H) 21

ABSORPTION AND MARGINAL COSTING Exemplar 4 Calculating sales volume and value Compo PLC produces a new type of compost for use in domestic greenhouses. The following information relates to Year 1 and Yea r 2 during which time all unit costs and revenues remained constant. Annual fixe d costs of production were 95,000. The compost was sold in 50 litre bags at 50 per bag. Variable costs of production which were constant over the 2 years are: Per litre 0.33 0.12 0.20 Materials Variable overhead Labour Production data litres produced Year 1 Year 2 900,000 1,000,000 Stock data 1 January Year 1 1 January Year 2 31 December Year 2 50,000 75,000 25 ,000 The production budget shows a normal level of activity of 950,000 litres per ann um. You are required to calculate for both years: (a) (b) (c) total sales value (assume no wastage) total variable costs charged to production (i) the fixed ove rhead absorption rate based on the normal level of activity 22 ABSORPTION AND MARGINAL COSTING (H)

ABSORPTION AND MARGINAL COSTING (ii) total fixed costs charged to production (iii) the value of over- or under-a bsorption of fixed costs (d) opening and closing stock values for use in (i) abs orption cost accounts (ii) marginal cost accounts the profit or loss earned (i) using absorption costing (ii) using marginal costing. (e) ABSORPTION AND MARGINAL COSTING (H) 23

ABSORPTION AND MARGINAL COSTING (a) Selling price per litre = 50/50 = 1 per litre Sales volume (litres) Year 1 50,000 900,000 950,000 75,000 875,000 Year 2 75,000 1,000,000 1,075,000 25,000 1,050,00 0 Opening stock Production Closing stock Sales Sales Year 1 = 875,000 1 = 875,000 Sa les Year 2 = 1,050,000 1 = 1,050,000 (b) Total variable costs charged to production Year 1 = 900,000 65p = 585,000 Total v ariable costs charged to production Year 2 = 1,000,000 65p = 650,000 (i) Fixed ov erhead absorption rate = 95,000/950,000 = 10p per litre Fixed costs charged to pr oduction Year 1 = 900,000 10p = 90,000 Fixed costs charged to production Year 2 = 1,000,000 10p = 100,000 (c) (ii) (iii) Under-absorbed overhead Year 1 = 95,000 90,000 = 5,000 (under) Over-absorbed overhead Year 2 = 95,000 100,000 = 5,000 (over) (d) Opening and closing stock value s (i) Absorption costing Total cost per unit = Variable cost per unit + Fixed co st per unit = 65p + 10p = 75p 1 January Year 1 = 50,000 75p = 37,500 31 December Year 1 = 75,000 75p = 56,250 31 December Year 2 = 25,000 75p = 18,750 24 ABSORPTION AND MARGINAL COSTING (H)

ABSORPTION AND MARGINAL COSTING (ii) Marginal costing 1 January Year 1 = 50,000 65p = 32,500 31 December Year 1 = 75,0 00 65p = 48,750 31 December Year 2 = 25,000 65p = 16,250 (e) (i) Profit statement using absorption costing Year 1 875,000 Year 2 1,050,000 56,250 650,000 100,000 806,250 18,750 Sales Less cost of sales Opening stock Variable costs Fixed costs 37,500 585,000 90,000 712,500 56,250 Closing stock 656,250 218,750 5,000 787,500 262,500 5,000 Less under-absorbed Add over-absorbed Profit 213,750 267,500 (ii) Profit statement using marginal costing Year 1 875,000 Year 2 1,050,000 48,750 6 50,000 698,750 16,250 Sales Less cost of sales Opening stock Variable costs 32,500 585,000 617,500 48,750 Closing stock Contribution Fixed costs Profit 568,750 306,250 95,000 211,250 682,500 367,500 95,000 272,500 ABSORPTION AND MARGINAL COSTING (H) 25

ABSORPTION AND MARGINAL COSTING Exercise 5 Rosie Paterson set up a micro-brewery on 1 January Year 1 to produce beers to sell in Scotland. She has provided the following information relating t o the year ended 31 December Year 1, when sales and production levels were 300,0 00 litres. Rosie Paterson has also estimated that there will no cost changes ove r the next 2 years. The normal level of activity in the brewery is 300,000 litre s per annum. Sales Production costs Direct materials Direct labour Variable over heads Fixed production overhead 1,200,000 240,000 300,000 48,000 240,000 828,000 Net profit Projected figures for the next 2 years are: Year 2 290,000 330,000 Ye ar 3 305,000 280,000 372,000 Sales (in litres) Production (in litres) There was no opening stock at the beginning of Year 2. You are required to prepa re statements showing the profits for Years 2 and 3 using: (a) (b) Absorption co sting Marginal costing. 26 ABSORPTION AND MARGINAL COSTING (H)

ABSORPTION AND MARGINAL COSTING Exercise 5 Solution (a) Profit statement using absorption costing Year 2 1,160,0 00 Year 3 1,220,000 110,400 224,000 280,000 44,800 224,000 883,200 41,400 Sales Less cost of sales Opening stock Direct materials (Note 2) 264,000 Direct labour (Note 3) 330,000 Variable overheads (Note 4) 52,800 264,000 Fixed costs ( Note 5) 910,800 110,400 Closing stock (Note 6) 800,400 359,600 841,800 378,200 (16,000) Less under-absorbed Add over-absorbed Profit 24,000 383,600 362,200 (b) Profit statement using marginal costing Year 2 1,160,000 Year 3 1,220,000 78,400 224,000 280,000 44,800 627,200 29,400 Sales Less cost of sales Opening stock Direct materials Direct labour Variable o verheads 264,000 330,000 52,800 646,800 78,400 Closing stock (Note 7) Contribution Fixed costs Profit 568,400 591,600 240,000 351,600 597,800 622,200 240,000 382,200 ABSORPTION AND MARGINAL COSTING (H) 27

ABSORPTION AND MARGINAL COSTING Note 1 calculation of unit costs Direct materials 240,000/300,000 litres = 80p pe r litre Direct labour 300,000/300,000 litres = 1 per litre Variable overheads 48,00 0/300,000 litres = 16p per litre Fixed production overheads 240,000/300,000 litre s = 80p per litre Note 2 direct materials Year 2 330,000 80p 264,000 Year 3 280,0 00 80p 224,000 Production cost per unit Note 3 direct labour Year 2 330,000 1 330,000 Year 3 280,000 1 280,000 Production unit rate Note 4 variable overheads Year 2 330,000 16p 52,800 Year 3 280,000 16p 44,800 Production unit rate Note 5 fixed costs Year 2 330,000 80p 264,000 Year 3 280,000 80p 224,000 Production cost per unit 28 ABSORPTION AND MARGINAL COSTING (H)

ABSORPTION AND MARGINAL COSTING Note 6 closing stock (units) Opening stock + Production Sales Year 2 330,000 330,000 290,000 40,000 Year 3 40,000 280,000 320,000 305,000 15,000 Closing stock (value) Units TCpu 40,000 2.76* 110,400 15,000 2.76 41,400 * (80p + 1 + 16p + 80p) Note 7 closing stock (value) Units VCpu 40,000 1.96* 78,400 * (80p + 1 + 16p) 15,000 1.96 29,400 ABSORPTION AND MARGINAL COSTING (H) 29

ABSORPTION AND MARGINAL COSTING Exercise 6 Carglass plc produces windscreens for cars at a standard selling pric e of 75 per unit. You are given the following anticipated figures for Years 2 and 3. Fixed costs of production for a normal year are 150,000 and normal production is 15,000 units. Variable costs per unit are: Direct materials Direct labour Va riable overheads Production data: Units produced 16,000 15,500 20 15 10 Year 2 Year 3 Stock data: Date 31 December Year 1 1 January Year 3 31 December Year 3 Units 1, 000 1,500 1,200 You are required to prepare statements showing the profits for Years 2 and 3 usi ng: (a) (b) Absorption costing Marginal costing. 30 ABSORPTION AND MARGINAL COSTING (H)

ABSORPTION AND MARGINAL COSTING Exercise 6 Solution (a) Profit statement using absorption costing Year 2 1,162,5 00 Year 3 1,185,000 82,500 310,000 232,500 155,000 155,000 935,000 66,000 Sales (Note 1) Less cost of sales Opening stock (Note 2) 55,000 Direct materials (Note 3) 320,000 Direct labour (Note 4) 240,000 Variable overheads (Note 5) 160 ,000 160,000 Fixed costs (Note 6) 935,000 82,500 Closing stock (Note 7) 852,500 310,000 869,000 316,000 5,000 321,000 Less under-absorbed Add over-absorbed Profit 10,000 320,000 (b) Profit statement using marginal costing Year 2 1,162,500 45,000 320,000 240,000 160,000 765,000 67,500 Year 3 1,185,000 67,500 310,000 232,500 155,000 765,000 5 4,000 Sales Less cost of sales Opening stock (Note 8) Direct materials Direct labour V ariable overheads Closing stock (Note 8) Contribution Fixed costs Profit 697,500 465,000 150,000 315,000 711,000 474,000 150,000 324,000 ABSORPTION AND MARGINAL COSTING (H) 31

ABSORPTION AND MARGINAL COSTING Year 2 Note 1 sales (units) Opening stock + Production Closing stock 1,000 16,00 0 17,000 1,500 15,500 1,162,500 Year 3 1,500 15,500 17,000 1,200 15,800 1,185,000 Sales (s) Note 2 closing stock (units) Value (VCpu + FCpu)

1,000 1,000 (45 + 10) 55,000 16,000 20 320,000 16,000 15 240,000 16,000 10 1 10* 160,000 * (150,000/15,000) 1,500 55 (TCpu) 82,500 1,000 45 (VCpu) 45,000 1, VCpu) 67,500

1,500 1,500 55 82,500 15,500 20 310,000 15,500 15 232,500 15,500 10 155,000 1 000 Note 3 direct materials Note 4 direct labour Note 5 variable overheads Note 6 fixed costs Note 7 closing stock 1,200 55 66,000 1,500 45 67,500 1,200 45 54,000 Note 8 opening stock Note 9 closing stock 32 ABSORPTION AND MARGINAL COSTING (H)