CIMA BA2 Syllabus B. COSTING - Calculate Profits Under Absorption and Marginal Costing - Notes 7 / 9
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 (Budgeted fixed overhead/Budgeted activity level) | 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 3 - Calculate the value of closing inventory under marginal costing
During October, 4,000 units of Product X were produced but only 3,600 units were sold.
At the beginning of October, there was no opening inventory.
Using marginal costing, what was the value of the inventory of Product X at the end of October?
$ | ||
---|---|---|
Direct materials | 1,000 | |
Direct labour | 9,000 | |
Variable production overhead | 2,000 | |
Fixed production overhead | 4,000 | |
Variable selling cost | 3,000 | |
Fixed distribution cost | 1,000 | |
Total cost incurred for product X | 20,000 | |
Solution
Total variable production costs = 1,000 + 9,000 + 2,000 = 12,000
Total production = 4,000 units
Cost per unit = 12,000 / 4,000 = $3
Total sales = 3,600
Closing inventory = 4,000 - 3,600 = 400 units x $3 = $12,00
Note that variable non production costs and fixed costs are not used to value inventory under marginal costing
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 |