absorption costing

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ABSORPTION AND MARGINAL COSTING ABSORPTION AND MARGINAL COSTING (H) 1 STUDENT NOTES Accountants and managers require financial information for many different purposes. To help make such decisions, costs can be classified in different ways: direct or indirect (in relation to production – product costs) fixed, variable or semi-variable (in relation to time – period costs). The difference in the treatment of fixed and variable costs is often crucial in making these decisions. The way fixed and variable costs are treated can give substantially different valuations of stock and hence profits. Dividing costs into product costs or period costs is essential in considering cost elements in absorption and marginal costing. Product costs: can be identified with a product, e.g. direct wages and direct materials. can be charged against revenue in the period when the products to which they relate are sold. form part of the valuation of stock of finished goods and work-in- progress. Period costs are not included in the valuations of stock. vary with production. Period costs: are those associated with time as opposed to product, e.g. annual insurance. can be charged against revenue in the period in which they are incurred. are usually fixed over a period of time, e.g. annual rent.

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Page 1: Absorption costing

ABSORPTION AND MARGINAL COSTING

ABSORPTION AND MARGINAL COSTING (H) 1

STUDENT NOTES

Accountants and managers require financial information for manydifferent purposes. To help make such decisions, costs can be classifiedin different ways:

• direct or indirect (in relation to production – product costs)• fixed, variable or semi-variable (in relation to time – period costs).

The difference in the treatment of fixed and variable costs is oftencrucial in making these decisions. The way fixed and variable costs aretreated can give substantially different valuations of stock and henceprofits.

Dividing costs into product costs or period costs is essential inconsidering cost elements in absorption and marginal costing.

Product costs:

• can be identified with a product, e.g. direct wages and directmaterials.

• can be charged against revenue in the period when the products towhich they relate are sold.

• form part of the valuation of stock of finished goods and work-in-progress. Period costs are not included in the valuations of stock.

• vary with production.

Period costs:

• are those associated with time as opposed to product, e.g. annualinsurance.

• can be charged against revenue in the period in which they areincurred.

• are usually fixed over a period of time, e.g. annual rent.

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Advantages of marginal costing

• Easy for non-accountants to understand and can be used withstandard costing systems.

• Can be used in break-even analysis.

• Fixed costs are incurred over a period of time. Such costs are nottherefore directly related to production and hence are not includedin the valuation of stock.

• Profits calculations are more realistic because they are related to thetime period during which they arise. Fixed costs are not carriedforward from one accounting period to the next. Assists whenchoices have to be made between alternatives, and contribution(selling price – variable costs) is a critical consideration.

• Pricing policy can be related to variable costs as fixed costs arededucted from total contribution. This can assist when makingdecisions regarding special orders.

• The unit cost is pre-determined. Problems arising from a variablefixed cost per unit are eliminated.

• Apportionment of overheads is required. Overhead apportionment isfrequently calculated on a subjective basis of the relationship betweenfixed costs and departmental activity.

• Under or over-absorption of overheads is avoided. (See section onunder and over-absorption of overheads). The procedures to dealwith under or over-absorption of overheads takes place when thelevel of activity differs from the pre-planned level.

• Useful when a costing is required for a specific decision thatmanagement is considering.

Advantages of absorption (total) costing

• Fixed costs are incurred as a natural part of production. Asabsorption costing includes all relevant production costs in valuingclosing stock a more realistic profit figure can be calculated.

• In marginal costing losses can occur in periods when sales are lowand total fixed costs are written off. If the goods are sold in a laterperiod then a distortion in the profit figures may arise.

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• Absorption costing gives better information for pricing products as itincludes both variable and fixed costs.

• Marginal costing may lead to lower prices being offered if the firm isoperating below capacity. Customers may still expect these lowerprices as demand/capacity increases.

Which method should be used?

As both methods have advantages and disadvantages, the precisemethod to use will depend on specific circumstances and the nature ofthe product/business. Where the viability of a product is desired,marginal costing would be used. However, a firm with a long-maturingproduct, such as whisky, may decide absorption costing is the moreappropriate method. Only one method will be used by a firm.

Over and under-absorption of overheads

In the first set of examples provided in this resource the problem ofover and under-absorption of overheads has been avoided by assumingthat the actual and normal or planned output are the same. This is anunrealistic assumption. Consider the following example.

Normal/planned production level 8,000 unitsNormal/planned fixed overheads £40,000Actual production 7,500 units

Fixed cost per unit = £40,000/8,000 = £5

Cost charged to production = 7,500 × £5 = £37,500

Under-absorbed fixed cost = £40,000 – £37,500 = £2,500

This means that £2,500 less than the actual fixed cost has been chargedto the finished products, thus this under-absorbed overhead must bededucted from the profit calculated.

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Exemplar 1

Normal production equals actual production

Consider the following information illustrating the manufacture of asingle product.

Selling price per unit £20Variable cost per unit £12Annual fixed cost £40,000Normal production level 10,000 unitsActual production level 10,000 unitsSales 9,500 units

The profit statement using absorption costing would appear as shownbelow.

Profit statement using absorption costing

£ £Sales (note 1) 190,000Less cost of salesVariable costs (Note 2) 120,000Fixed costs (Note 3) 40,000

160,000Closing stock (Note 4) 8,000 152,000

Profit £38,000

Note 1 Sales – 9500 units × £20 = £190,000

Note 2 Variable costs – 10,000 × £12 = £120,000

Note 3 Fixed costs – entered as actual figure

Note 4 Closing stock (units) = 10,000 – 9,500 = 500 unitsClosing stock valued at total cost per unit × number of unitsTotal cost per unit (TCpu) = Variable cost per unit (VCpu) +Fixed cost per unit (FCpu)Fixed cost per unit calculated on normal production level =£40,000 / 10,000 units = £4 per unitTCpu = £12 + £4 = £16Closing stock = 500 units × £16 = £8,000

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Profit statement using marginal costing

£ £Sales (Note 1) 190,000Less cost of salesVariable costs (Note 2) 120,000Closing stock (Note 5) 6,000 114,000

Contribution 76,000Fixed cost 40,000

Profit £36,000

Note 5• Closing stock valued at variable cost per unit × number of units• Closing stock = 500 × £12 = £6,000

As can be seen, the treatment of fixed costs has an influence on thevaluation of closing stock and the eventual profit. The following tableillustrates the differences.

Absorption Marginal

Closing stock £8,000 £6,000

Profit £38,000 £36,000

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Exercise 1From the following data relating to three firms, prepare two statementseach to show how profit is calculated using

(a) Absorption costing

(b) Marginal costing.

Firm A Firm B Firm CSelling price per unit £25 £10 £12Variable cost per unit £15 £4 £8Annual fixed cost £60,000 £20,000 £120,000Normal production level (units) 20,000 5,000 60,000Actual production level (units) 20,000 5,000 60,000Sales (units) 18,500 4,200 57,500

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Exercise 1 – Solution

Firm A

(a) Profit statement using absorption costing

£ £Sales 462,500Less cost of salesVariable costs 300,000Fixed costs 60,000

360,000Closing stock (Note 1) 27,000 333,000

Profit £129,500

(b) Profit statement using marginal costing

£ £Sales 462,500Less cost of salesVariable costs 300,000Closing stock (Note 2) 22,500 277,500

Contribution 185,000Fixed costs 60,000

Profit £125,000

Note 1• Fixed costs/Output = £60,000/20,000 units = £3 per unit• TCpu = VCpu + FCpu = £15 + £3 = £18• Closing stock (units) = Production – Sales = 20,000 – 18,500 = 1,500• 1,500 × £18 = £27,000

Note 2• Closing stock (units) × VCpu = 1,500 × £15 = £22,500

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Firm B

(a) Profit statement using absorption costing

£ £Sales 42,000Less cost of salesVariable costs 20,000Fixed costs 20,000

40,000Closing stock (Note 1) 6,400 33,600

Profit £8,400

(b) Profit statement using marginal costing

£ £Sales 42,000Less cost of salesVariable costs 20,000Closing stock (Note 2) 3,200 16,800

Contribution 25,200Fixed costs 20,000

Profit £5,200

Note 1• Fixed costs/Output = £20,000/5,000 units = £4 per unit• TCpu = VCpu + FCpu = £4 + £4 = £8• Closing stock (units) = Production – Sales = 5,000 – 4,200 = 800• 800 × £8 = £6,400

Note 2Closing stock (units) × VCpu = 800 × £4 = £3,200

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Firm C

(a) Profit statement using absorption costing

£ £Sales 690,000Less cost of salesVariable costs 480,000Fixed costs 120,000

600,000Closing stock (Note 1) 25,000 575,000

Profit £115,000

(b) Profit statement using marginal costing

£ £Sales 690,000Less cost of salesVariable costs 480,000Closing stock (Note 2) 20,000 460,000

Contribution 230,000Fixed costs

Profit £110,000

Note 1• Fixed costs/Output = £120,000/60,000 units = £2 per unit• TCpu = VCpu + FCpu = £8 + £2 = £10• Closing stock (units) = Production – Sales = 60,000 – 57,500 = 2,500• 2,500 × £10 = £25,000

Note 2Closing stock (units) × VCpu = 2,500 × £8 = £20,000

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Exemplar 2

Under and over-absorption of overheads

OTR plc sets up as a manufacturing business in Aberdeen. The sellingprice of its single product is £25 per unit. Direct material costs are £4per unit and the direct labour costs are £11 per unit. Annual fixed costsare £50,000 for a normal production level of 10,000 units. The followinginformation relates to production and sales for Year 1 and Year 2.

Year 1 Year 2Production (units) 11,500 9,500Sales (units) 10,000 10,500

You are required to prepare statements showing the valuation of stockand the profit figures for Years 1 and 2 using:

(a) Absorption costing

(b) Marginal costing.

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(a) Profit statement using absorption costing

Year 1 Year 2£ £ £ £

Sales (Note 1) 250,000 262,500Less cost of salesOpening stock 30,000Variable costs (Note 2) 172,500 142,500Fixed costs (Note 3) 57,500 47,500

230,000 220,000Closing stock (Note 4) 30,000 200,000 10,000 210,000

50,000 52,500Over/(under)-absorbed (Note 5) 7,500 (2,500)

Profit £57,500 £50,000

Note 1 – SalesYear 1 = 10,000 units × £25 = £250,000Year 2 = 10,500 units × £25 = £262,500

Note 2 – Variable costsYear 1 = 11,500 units × (£4 + £11) = £172,500Year 2 = 9,500 units × (£4 + £11) = £142,500

Note 3 – Fixed costsFixed cost per unit = £50,000/10,000 = £5Fixed cost charged to production in Year 1 = 11,500 × £5 = £57,500Fixed cost charged to production in Year 2 = 9,500 × £5 = £47,500

Note 4 – Closing stockYear 1 = (11,500 – 10,000) × (£4 + £11 + £5) = £30,000Year 2 = (1,500 + 9,500 – 10,500) × £20 = £10,000

Note 5 – Over/under-absorption of overheadsYear 1 = £57,500 – £50,000 = £7,500 over-absorbedYear 2 = £50,000 – £47,500 = £2,500 under-absorbed

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(b) Profit statement using marginal costing

Year 1 Year 2£ £ £ £

Sales (Note 1) 250,000 262,500Less cost of salesOpening stock 22,500Variable costs (Note 2) 172,500 142,500

172,500 165,000Closing stock (Note 6) 22,500 150,000 7,500 157,500

Contribution 100,000 105,000Fixed costs 50,000 50,000

Profit £50,000 £55,000

Note 6 – Closing stockYear 1 = 1,500 × £15 = £22,500Year 2 = 500 × £15 = £7,500

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Exercise 2

PLK plc sets up as a manufacturing business in Dundee. The sellingprice of its single product is £30 per unit. Direct material costs are £6per unit and the direct labour costs are £10 per unit. Annual fixed costsare £80,000 for a normal production level of 20,000 units. The followinginformation relates to production and sales for Year 1 and Year 2.

Year 1 Year 2Production (units) 19,000 20,500Sales (units) 18,000 19,500

You are required to prepare statements showing the valuation of stockand the profit figures for Year 1 and Year 2 using:

(a) Absorption costing

(b) Marginal costing.

Exercise 3

Annie Hall plc sets up as a manufacturing business in Kirkcaldy. Theselling price of her single product is £10 per unit. Direct material costsare £3 per unit and the direct labour costs are £2 per unit. Annual fixedcosts are £100,000 for a normal production level of 50,000 units. Thefollowing information relates to production and sales for Year 1 andYear 2.

Year 1 Year 2Production (units) 48,000 52,000Sales (units) 47,000 52,500

You are required to prepare statements showing the valuation of stockand the profit figures for Year 1 and Year 2 using:

(a) Absorption costing

(b) Marginal costing.

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Exercise 2 – Solution

(a) Profit statement using absorption costing

Year 1 Year 2£ £ £ £

Sales 540,000 585,000Less cost of salesOpening stock 20,000Variable costs 304,000 328,000Fixed costs 76,000 82,000

380,000 430,000Closing stock 20,000 360,000 40,000 390,000

180,000 195,000(Under)/Over-absorbed overheads (4,000) 2,000

Profit £176,000 £197,000

(b) Profit statement using marginal costing

Year 1 Year 2£ £ £ £

Sales 540,000 585,000Less cost of salesOpening stock 16,000Variable costs 304,000 328,000

304,000 344,000Closing stock 16,000 288,000 32,000 312,000

Contribution 252,000 273,000Fixed costs 80,000 80,000

Profit £172,000 £193,000

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Exercise 3 - Solution

(a) Profit statement using absorption costing

Year 1 Year 2£ £ £ £

Sales 470,000 525,000Less cost of salesOpening stock 7,000Variable costs 240,000 260,000Fixed costs 96,000 104,000

336,000 371,000Closing stock 7,000 329,000 3,500 367,500

141,000 157,500(Under)/Over-absorbed overheads (4,000) 4,000

Profit £137,000 £161,500

(b) Profit statement using marginal costing

Year 1 Year 2£ £ £ £

Sales 470,000 525,000Less cost of salesOpening stock 5,000Variable costs 240,000 260,000

240,000 265,000Closing stock 5,000 235,000 2,500 262,500

Contribution 235,000 262,500Fixed costs 100,000 100,000

Profit £135,000 £162,500

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Exemplar 3

Using overhead absorption rates

Thompson and Burnett are a manufacturing partnership. During Year 1the following information becomes available.

Sales £800,000

CostsDirect material £250,000Direct labour (£12 per labour hour) £240,000Variable production overheads £150,000Fixed production overheads £124,000Fixed selling and distribution expenses £25,000

Information regarding opening and closing stock is as follows:

Direct Direct Variable FixedMaterial Labour Production Production

Overhead Overhead1 Jan £60,000 £36,000 £18,000 ?31 Dec £75,000 £48,000 £35,000 ?

Fixed overheads are recovered at £6 per direct labour hour.

You are required to prepare two profit statements using:

(a) Absorption costing

(b) Marginal costing.

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(a) Profit statement for Year 1 using absorption costing

£ £Sales 800,000Less cost of salesOpening stock (Note 1) 132,000Direct material 250,000Direct labour 240,000Variable production overhead 150,000Fixed production overhead (Note 2) 120,000

892,000Closing stock (Note 3) 182,000 710,000

90,000Less under-absorbed overhead (Note 4) 4,000

86,000Fixed selling and distribution expenses 25,000

Profit £61,000

Note 1Number of labour hours charged to opening stock = £36,000/12 = 3,000Fixed overhead charged to opening stock = 3,000 × £6 per hour =£18,000Valuation of stock = £60,000 + £36,000 + £18,000 + £18,000 = £132,000

Note 2Fixed overhead charged to production.

Number of labour hours worked = £240,000/£12 = 20,000Fixed overhead charged to production = 20,000 × £6 = £120,000

Note 3Number of labour hours charged to closing stock = £48,000/12 = 4,000Fixed overhead charged to closing stock = 4,000 × £6 per hour =£24,000Valuation of stock = £75,000 + £48,000 + £35,000 + £24,000 = £182,000

Note 4Under-absorbed overhead = £124,000 – £120,000 = £4,000

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(b) Profit statement for Year 1 using marginal costing

£ £Sales 800,000Less cost of salesOpening stock (Note 5) 114,000Direct material 250,000Direct labour 240,000Variable production overhead 150,000

754,000Closing stock (Note 6) 158,000 596,000

Contribution 204,000Fixed production overheads 124,000Fixed selling and distribution expenses 25,000 149,000

Profit £55,000

Note 5Valuation of stock = £60,000 + £36,000 + £18,000 = £114,000

Note 6Valuation of stock = £75,000 + £48,000 + £35,000 = £158,000

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Exercise 4Telfer and Burrows are a manufacturing partnership. During Year 1 thefollowing information becomes available.

Sales £600,000

CostsDirect material £175,000Direct labour (£10 per labour hour) £180,000Variable production overheads £90,000Fixed production overheads £75,000Fixed selling and distribution expenses £45,000

Information regarding opening and closing stock is as follows.

Direct Direct Variable FixedMaterial Labour Production Production

Overhead Overhead1 Jan £15,000 £18,000 £12,000 ?31 Dec £30,000 £24,000 £20,000 ?

Fixed overheads are recovered at £4 per direct labour hour.

You are required to prepare two profit statements using:

(a) Absorption costing

(b) Marginal costing.

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Exercise 4 – Solution

(a) Profit statement for Year 1 using absorption costing

£ £Sales 600,000Less cost of salesOpening stock (Note 1) 52,200Direct material 175,000Direct labour 180,000Variable production overhead 90,000Fixed production overhead (Note 2) 72,000

569,200Closing stock (Note 3) 83,600 485,600

114,400Less under-absorbed overhead (Note 4) (3,000)

111,400Fixed selling and distribution expenses 45,000

Profit £66,400

Note 1Number of labour hours charged to opening stock = £18,000/£10 =1,800Fixed overhead charged to opening stock = 1,800 × £4 = £7,200Valuation of stock = £15,000 + £18,000 + £12,000 +£7,200 = £52,200

Note 2Fixed overhead charged to production

Number of labour hours worked = £180,000/£10 = 18,000Fixed overhead charged to production = 18,000 × £4 = £72,000

Note 3Number of labour hours charged to closing stock = £24,000/£10 = 2,400Fixed overhead charged to closing stock = 2,400 × £4 = £9,600Valuation of stock = £30,000 + £24,000 + £20,000 + £9,600 = £83,600

Note 4Under-absorbed overhead = £75,000 – £72,000 = £3,000

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(b) Profit statement for Year 1 using marginal costing

£ £Sales 600,000Less cost of salesOpening stock 45,000Direct material 175,000Direct labour 180,000Variable production overhead 90,000

490,000Closing stock 74,000 416,000

Contribution 184,000Fixed production overheads 75,000Fixed selling and distribution expenses 45,000 120,000

Profit £64,000

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Exemplar 4

Calculating sales volume and value

Compo PLC produces a new type of compost for use in domesticgreenhouses.

The following information relates to Year 1 and Year 2 during whichtime all unit costs and revenues remained constant.

Annual fixed costs of production were £95,000.

The compost was sold in 50 litre bags at £50 per bag.

Variable costs of production which were constant over the 2 years are:

Per litreMaterials £0.33Variable overhead £0.12Labour £0.20

Production data – litres produced

Year 1 900,000Year 2 1,000,000

Stock data

1 January Year 1 50,0001 January Year 2 75,00031 December Year 2 25,000

The production budget shows a normal level of activity of 950,000 litresper annum.

You are required to calculate for both years:

(a) total sales value (assume no wastage)

(b) total variable costs charged to production

(c) (i) the fixed overhead absorption rate based on the normal levelof activity

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(ii) total fixed costs charged to production(iii) the value of over- or under-absorption of fixed costs

(d) opening and closing stock values for use in(i) absorption cost accounts(ii) marginal cost accounts

(e) the profit or loss earned(i) using absorption costing(ii) using marginal costing.

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(a) Selling price per litre = £50/50 = £1 per litre

Sales volume (litres)

Year 1 Year 2Opening stock 50,000 75,000Production 900,000 1,000,000

950,000 1,075,000Closing stock 75,000 25,000Sales 875,000 1,050,000

Sales Year 1 = 875,000 × £1 = £875,000Sales Year 2 = 1,050,000 × £1 = £1,050,000

(b) Total variable costs charged to production Year 1 = 900,000 × 65p= £585,000Total variable costs charged to production Year 2 = 1,000,000 ×65p = £650,000

(c) (i) Fixed overhead absorption rate = £95,000/950,000 = 10p perlitre

(ii) Fixed costs charged to production Year 1 = 900,000 × 10p =£90,000Fixed costs charged to production Year 2 = 1,000,000 × 10p= £100,000

(iii) Under-absorbed overhead Year 1 = £95,000 – £90,000 =£5,000 (under)Over-absorbed overhead Year 2 = £95,000 – £100,000 =£5,000 (over)

(d) Opening and closing stock values

(i) Absorption costing

Total cost per unit = Variable cost per unit + Fixed cost perunit = 65p + 10p = 75p

1 January Year 1 = 50,000 × 75p = £37,50031 December Year 1 = 75,000 × 75p = £56,25031 December Year 2 = 25,000 × 75p = £18,750

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(ii) Marginal costing

1 January Year 1 = 50,000 × 65p = £32,50031 December Year 1 = 75,000 × 65p = £48,75031 December Year 2 = 25,000 × 65p = £16,250

(e) (i) Profit statement using absorption costing

Year 1 Year 2£ £ £ £

Sales 875,000 1,050,000Less cost of salesOpening stock 37,500 56,250Variable costs 585,000 650,000Fixed costs 90,000 100,000

712,500 806,250Closing stock 56,250 656,250 18,750 787,500

218,750 262,500Less under-absorbed 5,000Add over-absorbed 5,000

Profit £213,750 £267,500

(ii) Profit statement using marginal costing

Year 1 Year 2£ £ £ £

Sales 875,000 1,050,000Less cost of salesOpening stock 32,500 48,750Variable costs 585,000 650,000

617,500 698,750Closing stock 48,750 568,750 16,250 682,500

Contribution 306,250 367,500Fixed costs 95,000 95,000

Profit £211,250 £272,500

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Exercise 5Rosie Paterson set up a micro-brewery on 1 January Year 1 to producebeers to sell in Scotland. She has provided the following informationrelating to the year ended 31 December Year 1, when sales andproduction levels were 300,000 litres. Rosie Paterson has also estimatedthat there will no cost changes over the next 2 years. The normal levelof activity in the brewery is 300,000 litres per annum.

£ £Sales 1,200,000Production costsDirect materials 240,000Direct labour 300,000Variable overheads 48,000Fixed production overhead 240,000

828,000

Net profit £372,000

Projected figures for the next 2 years are:

Year 2 Year 3Sales (in litres) 290,000 305,000Production (in litres) 330,000 280,000

There was no opening stock at the beginning of Year 2.

You are required to prepare statements showing the profits for Years 2and 3 using:

(a) Absorption costing

(b) Marginal costing.

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Exercise 5 – Solution

(a) Profit statement using absorption costing

Year 2 Year 3£ £ £ £

Sales 1,160,000 1,220,000Less cost of salesOpening stock 110,400Direct materials (Note 2) 264,000 224,000Direct labour (Note 3) 330,000 280,000Variable overheads (Note 4) 52,800 44,800Fixed costs (Note 5) 264,000 224,000

910,800 883,200Closing stock (Note 6) 110,400 800,400 41,400 841,800

359,600 378,200Less under-absorbed (16,000)Add over-absorbed 24,000

Profit £383,600 £362,200

(b) Profit statement using marginal costing

Year 2 Year 3£ £ £ £

Sales 1,160,000 1,220,000Less cost of salesOpening stock 78,400Direct materials 264,000 224,000Direct labour 330,000 280,000Variable overheads 52,800 44,800

646,800 627,200Closing stock (Note 7) 78,400 568,400 29,400 597,800

Contribution 591,600 622,200Fixed costs 240,000 240,000

Profit £351,600 £382,200

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Note 1 – calculation of unit costsDirect materials – £240,000/300,000 litres = 80p per litreDirect labour – £300,000/300,000 litres = £1 per litreVariable overheads – £48,000/300,000 litres = 16p per litreFixed production overheads – £240,000/300,000 litres = 80p per litre

Note 2 – direct materials

Year 2 Year 3Production × cost per unit 330,000 × 80p 280,000 × 80p

£264,000 £224,000

Note 3 – direct labour

Year 2 Year 3Production unit rate 330,000 × £1 280,000 × £1

£330,000 £280,000

Note 4 – variable overheads

Year 2 Year 3Production × unit rate 330,000 × 16p 280,000 × 16p

£52,800 £44,800

Note 5 – fixed costs

Year 2 Year 3Production × cost per unit 330,000 × 80p 280,000 × 80p

£264,000 £224,000

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ABSORPTION AND MARGINAL COSTING (H) 2 9

Note 6 – closing stock (units)

Year 2 Year 3Opening stock - 40,000+ Production 330,000 280,000

330,000 320,000– Sales 290,000 305,000

40,000 15,000

Closing stock (value)Units × TCpu 40,000 × £2.76* 15,000 × £2.76

£110,400 £41,400

* (80p + £1 + 16p + 80p)

Note 7 – closing stock (value)

Units × VCpu 40,000 × £1.96* 15,000 × £1.96£78,400 £29,400

* (80p + £1 + 16p)

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ABSORPTION AND MARGINAL COSTING (H)3 0

Exercise 6

Carglass plc produces windscreens for cars at a standard selling price of£75 per unit. You are given the following anticipated figures for Years 2and 3. Fixed costs of production for a normal year are £150,000 andnormal production is 15,000 units.

Variable costs per unit are:

Direct materials £20Direct labour £15Variable overheads £10

Production data:

Units producedYear 2 16,000Year 3 15,500

Stock data:

Date Units31 December Year 1 1,0001 January Year 3 1,50031 December Year 3 1,200

You are required to prepare statements showing the profits for Years 2and 3 using:

(a) Absorption costing

(b) Marginal costing.

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ABSORPTION AND MARGINAL COSTING (H) 3 1

Exercise 6 – Solution

(a) Profit statement using absorption costing

Year 2 Year 3£ £ £ £

Sales (Note 1) 1,162,500 1,185,000Less cost of salesOpening stock (Note 2) 55,000 82,500Direct materials (Note 3) 320,000 310,000Direct labour (Note 4) 240,000 232,500Variable overheads (Note 5) 160,000 155,000Fixed costs (Note 6) 160,000 155,000

935,000 935,000Closing stock (Note 7) 82,500 852,500 66,000 869,000

310,000 316,000Less under-absorbedAdd over-absorbed 10,000 5,000

Profit £320,000 £321,000

(b) Profit statement using marginal costing

Year 2 Year 3£ £ £ £

Sales 1,162,500 1,185,000Less cost of salesOpening stock (Note 8) 45,000 67,500Direct materials 320,000 310,000Direct labour 240,000 232,500Variable overheads 160,000 155,000

765,000 765,000Closing stock (Note 8) 67,500 697,500 54,000 711,000

Contribution 465,000 474,000Fixed costs 150,000 150,000

Profit £315,000 £324,000

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ABSORPTION AND MARGINAL COSTING (H)3 2

Year 2 Year 3

Note 1 – sales (units)

Opening stock 1,000 1,500+ Production 16,000 15,500

17,000 17,000– Closing stock 1,500 1,200

15,500 15,800

Sales (£s) £1,162,500 £1,185,000

Note 2 – closing stock (units)

1,000 1,500Value (VCpu + FCpu) 1,000 × (£45 + £10) 1,500 × £55

£55,000 £82,500

Note 3 – direct materials 16,000 × £20 15,500 × £20£320,000 £310,000

Note 4 – direct labour 16,000 × £15 15,500 × £15£240,000 £232,500

Note 5 – variable overheads 16,000 × £10 15,500 × £10£160,000 £155,000

Note 6 – fixed costs 16,000 × £10* 15,500 × £10£160,000 £155,000

* (£150,000/15,000)

Note 7 – closing stock 1,500 × £55 (TCpu) 1,200 × £55£82,500 £66,000

Note 8 – opening stock 1,000 × £45 (VCpu) 1,500 × £45£45,000 £67,500

Note 9 – closing stock 1,500 × £45 (VCpu) 1,200 × £45£67,500 £54,000