Profit or Loss 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 COS

  • In 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$$
Salesx
LESS:Variable cost of sales:
Opening inventoryx
Production costsx
Variable Production Overhead costsx
x
LESS:Closing inventory(x)
(x)
x
LESS:Variable selling, dist, admin costs(x)
Contributionx
LESS:Fixed costs (actual incurred):
Productionx
Selling and distributionx
Administrationx
(x)
Net profitx

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$$
Salesx
LESSCost of sales
Opening inventoryx
Production costsx
Variable production overhead costsx
Fixed overhead absorbedx
x
LESSClosing inventory(x)
(x)
Fixed overhead (under)/over absorbedx/(x)
Gross profitx
LESSSelling, admin etc costs
(non production)(x)
Net profitx

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 costs6
Fixed production overhead  costs (OAR) 4
Gross profit10

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
–––––––
Contribution = $85,305
Less fixed overhead = $35,305 (17,450 + 17,855)
–––––––
Profit $50,000

Marginal costingAbsorption costing
Closing inventories are valued at Marginal production costClosing inventories are valued at full Production cost
Fixed costs are period costsFixed costs are absorbed into unit costs
Cost of sales does not include a share Of fixed overheadsCost of sales does include a share of fixed overheads

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