CIMA P1 Syllabus A. Cost Accounting For Decision And Control - Profit or Loss - Notes 4 / 10
Profit or loss
Profit or loss under absorption and marginal costing
In marginal costing, fixed production costs:
- are not included in the COS
- are treated as period costs (are written off as they are incurred)In absorption costing, fixed production costs
- are absorbed into the cost of units
- are included in the COSIn the long run, total profit for a company will be the same whether marginal costing or absorption costing is used.
Profit under Marginal costing
Marginal costing income statement | $ | $ | |
Sales | x | ||
LESS: | Variable cost of sales: | ||
Opening inventory | x | ||
Production costs | x | ||
Variable Production Overhead costs | x | ||
x | |||
LESS: | Closing inventory | (x) | |
(x) | |||
x | |||
LESS: | Variable selling, dist, admin costs | (x) | |
Contribution | x | ||
LESS: | Fixed costs (actual incurred): | ||
Production | x | ||
Selling and distribution | x | ||
Administration | x | ||
(x) | |||
Net profit | x |
Note that inventories are valued at variable production costs only.
Illustration 1
A company produced 1,000 units of Product A.
The opening and closing inventory was 100 units and 500 units respectively.
The selling price and production costs for Product A were as follows:
Selling price | $30 per unit |
Direct costs | $10 per unit |
Variable production overhead costs | $6 per unit |
Total Fixed production overhead costs | 4,000 |
What is the Gross profit for Product A, using marginal costing?
Solution
Number of units sold = (OP + Produced - CL) = (100 + 1,000 - 500) = 600 units
Contribution per unit = 30 - 10 - 6 = $14 per unit
Contribution = 600u x Contribution $14= $8,400
Gross Profit = $8,400 - Fixed OH $4,000 = $4,400
Profit under Absorption costing
Absorption costing income statement | $ | $ | |
Sales | x | ||
LESS | Cost of sales | ||
Opening inventory | x | ||
Production costs | x | ||
Variable production overhead costs | x | ||
Fixed overhead absorbed | x | ||
x | |||
LESS | Closing inventory | (x) | (x) |
Fixed overhead (under)/over absorbed | x/(x) | ||
Gross profit | x | ||
LESS | Selling, admin etc costs | ||
(non production) | (x) | ||
Net profit | x |
Note that inventories are valued at full production cost
Illustration 2
A company produced 1,000 units of Product A.
The opening and closing inventory was 100 units and 500 units respectively.
There was no under or over absorption of fixed overheads.
The selling price and production costs for Product A were as follows:
$ per unit | |
Selling price | 30 |
Direct costs | 10 |
Variable production overhead costs | 6 |
Fixed production overhead costs (OAR) | 4 |
Gross profit | 10 |
What is the Gross profit for Product A, using absorption costing?
Number of units sold = (OP + Produced - CL) = (100 + 1,000 - 500) = 600 units
Gross Profit = 600u x Gross profit $10 = $6,000
Illustration:
A company produces a single item which is sold for $80 per unit. The budgeted data for the latest period are as follows:
Production and sales volume: 1,250 units
Material cost: $6,250
Direct labour cost: $3,000
Production overhead: $17,450
Non-production overhead: $17,855
Actual production volume and costs were as budgeted for the period, but the actual sales volume achieved was 1,175 units. There was no inventory at the beginning of the period.
What is the profit for the period using marginal costing?
Solution:
Value of closing inventory = $(6,250 + 3,000) × 75/1,250 = $555
Sales = $94,000 (1,175 x $80)
Variable cost of production = $9,250 (6,250 + 3,000)
Less closing inventory = $555
––––––
Cost of sales $8,695
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Contribution = $85,305
Less fixed overhead = $35,305 (17,450 + 17,855)
–––––––
Profit $50,000
Marginal costing | Absorption costing |
Closing inventories are valued at Marginal production cost | Closing inventories are valued at full Production cost |
Fixed costs are period costs | Fixed costs are absorbed into unit costs |
Cost of sales does not include a share Of fixed overheads | Cost of sales does include a share of fixed overheads |