Absorption and Marginal Costing Lesson 3 1 Absorption
Absorption and Marginal Costing Lesson 3 1
Absorption Costing and Marginal Costing Methods to compute net income for financial reporting purpose Absorption Costing Marginal Costing 2
Features of Marginal Costing 1. Marginal product costs can be defined as the additional costs of producing an extra unit of output. 2. Product costs under marginal costing = Direct materials + direct labour + direct expenses + variable production overheads. 3. Marginal cost of goods sold = Marginal product costs. 3
Features of Marginal Costing 4. Fixed production overheads and all non-production overheads are treated as period costs. 5. The valuation of closing inventory contains only variable elements. 6. Marginal costing provides more useful information for decision making, for example, price of an ad-hoc order is determined on the basis of marginal product costs. 4
Cost Flow of Marginal Costing Cost Production Costs Direct materials Direct labour Variable POH Non-production Costs POH Expenses Fixed POH Product costs Cost of goods sold Income Statement 5
Prepare an income statement under marginal costing 6
Format of Income Statement under Marginal Costing Income Statement for the year ended 31 December 20 XX $ $ Sales x Less: Variable cost of goods sold Opening inventory x Add: Direct materials x Add: Direct labour x Add: Direct expenses x Add: Variable production overheads x x Less: Closing inventory x x x Less: Variable non – production overheads x Contribution margin x Less: Fixed production overheads x Fixed non – production overheads x x Net operating profit x 7
Definition of Contribution Margin (CM) 1. It is the difference between sales and the total variable costs. i. e. sales – total variable costs* = contribution margin 2. Contribution margin - total fixed costs** = net operating profit. 3. It can be calculated in total or per unit cost. 8
Illustration ABC Company produces a single product that is sold for $100. This year, the company produced 50, 000 units and sold 44, 000 units of goods with the following cost information: Variable costs per unit: Direct materials Direct labour Production overheads Selling and administrative overheads (per unit sold) Fixed costs per year: Production overheads Selling and administrative overheads $20 $15 $ 8 $ 6 $600, 000 $450, 000 9
Required: Under marginal costing, a. Calculate the following: 1. Product costs per unit 2. The value of closing inventory 3. Total selling and administrative overheads 4. Total contribution margin 5. Net operating profit b. Prepare an income statement for the year 10
Illustration – Solution a. 1. Product costs per unit = DM + DL + VPOH = $20 + $15 + $8 = $43 2. The value of closing inventory = Product costs per unit x units remained unsold in closing inventory = $43 x (50, 000 - 44, 000) = $258, 000 3. Total selling and administrative overheads = Variable selling and administrative overheads per unit x units sold + total fixed selling and administrative overheads = $6 x 44, 000 + $450, 000 = $714, 000 11
Illustration – Solution 4. Total contribution margin = (Selling price – product costs – variable selling and administrative overheads) x units sold = ($100 - $43 - $6) x 44, 000 = $2, 244, 000 5. Net operating profit = Total contribution margin – fixed production overheads - fixed selling and administrative overheads = $2, 244, 000 - $600, 000 - $450, 000 = $1, 194, 000 12
b. ABC Company Income Statement for the year $’ 000 Sales ($100 x 44, 000) $’ 000 4, 400 Less: Variable cost of goods sold Direct materials ($20 x 50, 000) 1, 000 Add: Direct labour ($15 x 50, 000) 750 Add: Variable POH ($8 x 50, 000) 400 2, 150 Less: Closing inventory ($43 x 6, 000) 258 1, 892 2, 508 Less: Variable selling and administrative OH ($6 x 44, 000) 264 Contribution margin Less: Fixed production overheads Fixed selling and administrative overheads Net operating profit 2, 244 600 450 1, 050 1, 194 13
(Alternative answer) b. ABC Company Income statement for the year Sales Less: Total variable costs ($49* x 44, 000) Contribution margin Less: Total fixed costs 1, 050, 000 Net operating profit $ 4, 400, 000 2, 156, 000 2, 244, 000 1, 194, 000 * Total variable costs per unit = $20 +$15 + $8 + $6 = $49 14
Determining the Value of Ending Inventory We use weighted average cost method to determine the value of ending inventory in case there is inventory brought forward from the last period. 1. Determine the number of units in the ending inventory = Beginning inventory units + units produced – units sold 2. Determine the average product costs per unit = (Value of beginning inventory + product costs per unit x units produced) ÷ total units* 3. Determine the value of ending inventory = Average product costs per unit x ending inventory units 15
Illustration XYZ Company manufactures Product A and adopts marginal costing method to determine its net income. The company also uses weighted average cost method for the valuation of inventory. There were 1, 000 units with the variable production costs of $60 each at the beginning inventory of finished goods. This year, the company produced 16, 000 units and sold 14, 500 units of goods with the following cost information: Variable costs per unit: Direct materials $20 Direct labour $15 Production overheads $8 Required: a. Calculate the ending inventory units. b. Calculate the value of ending inventory. 16
Illustration – Solution a. Ending inventory units = Beginning inventory units + units produced – units sold = (1, 000 + 16, 000 – 14, 500) units = 2, 500 units b. The average variable product costs per unit = (Value of beginning inventory + variable product costs per unit x units produced) ÷ total units = [$60 x 1, 000 + ($20 + $15 + $8) x 16, 000)] ÷ 17, 000 = $44 Therefore, the value of ending inventory = Average variable product costs per unit x ending inventory units = $44 x 2, 500 = $110, 000 17
Classwork The following data is extracted from the classwork in Lesson 2: The actual production units and actual sales units for 2018 were 25, 000 units and 20, 000 units respectively. Other actual data for 2018 was as follows: Selling price Direct materials Direct labour Variable production overheads Variable selling overheads $ per unit 27 6 3 2 1 18
Fixed production overheads Fixed selling overheads Fixed administrative overheads $ 105, 000 7, 000 12, 000 Required: Under marginal costing, a. Calculate the following: 1. Product costs per unit 2. The value of closing inventory 3. Total contribution margin b. Prepare an income statement for the year ended 31 December 2018. 19
Classwork - Solution a. 1. Product costs per unit = DM + DL + VPOH = $6 + $3 + $2 = $11 2. The value of closing inventory = $11 x 5, 000 = $55, 000 3. The total contribution margin = $(27 – 11 – 1) x 20, 000 = $300, 000 20
b. ABC Company Income Statement for the year ended 31 December 2018 $’ 000 Sales ($27 x 20, 000) 540 Less: Variable cost of goods sold Direct materials ($6 x 25, 000) 150 Add: Direct labour ($3 x 25, 000) 75 Add : Variable POH ($2 x 25, 000) 50 275 Less: Closing inventory ($11 x 5, 000) 55 220 320 Less: Variable selling overheads ($1 x 20, 000) 20 Contribution margin 300 21
Cont’d $’ 000 Contribution margin 300 Less: Fixed production overheads 105 Fixed selling overheads 7 Fixed administrative overheads Net operating profit 12 176 22
Key Points Covered 1. Features of marginal costing. 2. Cost flow of marginal costing. 3. Calculation of the value of ending inventory using weighted average cost method. 4. An income statement under marginal costing. 23
Homework: Q 3 24
END 25
- Slides: 25
