Profit or Loss

NotesQuizObjective Test

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 $ $
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

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
NotesQuizObjective Test