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furqan.90 says

QUESTION

A company produces and sells a single product whose variable cost is $6 per unit.

Fixed costs have been absorbed over the normal level of activity of 200,000 units and have been

calculated as $2 per unit.

The current selling price is $10 per unit.

How much profit is made under marginal costing if the company sells 250,000 units?

A $500,000

B $600,000

C $900,000

D $1,000,000

SOLUTION

Contribution per unit = selling price – variable cost

= $10 – $6

= $4 per unit

Total contribution = 250,000 units × $4 per unit = $1,000,000

Total fixed costs = 200,000 units × $2 per unit

= $400,000

Marginal costing profit = total contribution – total fixed costs

= $1,000,000 – $400,000

= $600,000

Hi, could anyone explain why in marginal costing fixed costs were calcaulated on the basis of budgeted level of activity rather than actual level of activity.

Its been a long time since i have studied for exams and i cant recall the logic

Thanks,

Furqan

John Moffat says

You must ask this sort of question in the F2 Ask the Tutor Forum, and not as a comment on a lecture.

The absorption rate is always based on budgeted overheads and budgeted production. Therefore the budget overheads are 400,000. Unless told differently we have no choice but to assume that the actual overheads are the same as the budget overheads.

I do suggest that you watch all of our lectures – they are a complete course for Paper F2 and cover everything needed to be able to pass the exam well.

furqan.90 says

Thanks John,sorry i didnt know the right forum to ask the question.

Actually i am studying for f5,i paased f2 a few years ago but than had to take some time away from studies.

Furqan

maria says

Dear Mr. Moffat,

I have problems with understanding the example 3 from Chapter 9 (comparing the profits under marginal and absorbtion costing). I understood it only arithmetically while doing previous examples, but confused with the logic.

If Production>Sales, we have closing inventory. Cost per unit by absorbion costing is MORE than cost per unit by marginal costing => we exclude closing inventory amount MORE in absorbtion costing than in marginal costing, therefore, the profit must be LESS in absorbion costing than in marginal costing. But as we calculated from previous examples, profit by absorbtion costing is MORE than profit in marginal costing, when production>sales. I confused about this question and can only learn the rule without clear understanding.

Could you please explain more detailed this question?

Thanks in advance,

Maria.

John Moffat says

If production > sales, then the inventory will increase over the period.

Marginal costing charges all of the fixed overheads in the period in which they are incurred.

Absorption costing charges on what was sold during the period (the cost of goods sold includes only the fixed overheads per unit on the number sold).

So if the sales are less than production (so inventory increases), then with absorption costing a smaller amount will have been charged for fixed overheads and therefore the profit will be higher.

If sales are more than production (so inventory decreases) then with absorption costing a larger amount will have been charged for fixed overheads and therefore the profit will be lower than with marginal costing.

maria says

Thank you very much, Mr. Moffat! Now I got the point!

John Moffat says

You are welcome

laura says

Hi,

I have struggled with working out February and the difference between Absorption and Marginal so I’ve sat down and worked things out and have come to the same answer for both of £81,000? I could just be over thinking this as I expected a difference as with January. Am I right in thinking that there is no difference as there was no closing inventory in February or have I gone completely wrong somewhere in my figures?

Thanks,

Laura

John Moffat says

There is a difference, because what causes the difference is the change in the inventory over the period.

Have you watched the lecture, because I actually work through the figures for February (and, of course, the answer is also at the back of the lecture notes)?

khanhhoangvu says

Dear Sir,

Could you please help me to understand more clearly in the answer for part b of example 1 .

Herebelow is my opinions for solution, and I hope You will find out my misunderstand.

Profit statement

Juanuary ($) February ($)

Sales (9.000u x $35) 315.000 (11.500u x $35) 402.500

Less cost of sales:

Opening Inv – (2.000u x $25) (50.000)

Production Cost:

Material ( 11.000u x $12) (132.000) (9.500u x $12) (114.000)

Labour (11.000u x $8) ( 88.000) (9.500u x $8) (76.000)

Varia O/H (11.000u x $5) (55.000) (9.500u x $5) (47.500)

Less Closing Inv

(2.000u x $25) (50.000) –

Less other Variable cost:

Selling cost: (9.000u x $1) (9.000) (11.500u x $1) (11.500)

————– ————-

Contribution: (19.000) 103.500

—————- ————-

Less Fixed cost:

Fixed production: (20.000) (20.000)

Fixed selling cost: (2.000) (2.000)

———— ———–

Total net profit $ (41.000) $ 81.500

————— ————

Tks very much, and hope to receiving your reply

John Moffat says

In January, the cost of sales is (132,000+88,000+55,000) – 50,000 = 225,000.

Therefore the contribution is 315,000 (sales) – 225,000 (cost of sales) – 9,000 (other variable) = 81,000. (not (19,000) )

You have made the same mistake for February.

khanhhoangvu says

Dear Sir,

The formula to calculate the net profit in January will be:

Net profit in January = Sales – Opening Inventory – Cost of sales – Closing Inventory – other variable cost – Total fiexd cost

= $315.000 – $0 – $275.000 (132.000+88.000+55.000) – $50.000 – $9.000 – $22.000 (20.000+2.000) = -$41.000.

Where as: Cost of sale = direct materials + direct labour + variable o/v = $132.000 + $88.000 + $55.000 = $275.000

Is my formula is correct? If I have any mistake in above formula, Could you please help me to understand more clearly by explaining detailed.

In your above explain, why thee cost of sales is = $225.000 . Could you help me to understand well of $225.000 because In my views, I think the cost of sales = direct materials + direct labour + variable o/v = $132.000 + $88.000 + $55.000 = $275.000.

Looking to receiving your reply soon.

Tks and best regards

John Moffat says

Firstly you should not learn it just as formulae – the exam deliberately finds ways of testing that you understand, and that you are not simply learning it as rules.

Secondly, the contribution is sales less cost of sales less other variable costs, we then subtract the fixed costs to get the profit.

What you have written for the cost of sales is in fact the cost of production. The production is not all sold and so the cost of sales – opening inventory + cost of production – closing inventory.

Finally, instead of working out all the figure separately, it is much quicker to get the total contribution by simply multiplying the units sold by the contribution per unit. There is enormous time pressure in the exam and you will not have time to calculate all the individual figure as you have done.

I really do suggest that you watch the lecture again!

Rachel says

Mr. Moffat,

I’m having some difficulty on question 4 in the test for this chapter. The answer explains that in the case that closing inventory is greater than opening inventory, then closing inventory should be subtracted (rather than added) and opening inventory added to the profit under absorption costing in order to get to Marginal Costing. In example 1 of this chapter, don’t we have a similar situation where closing inventory for January is greater than opening (4000 vs 0) but we added it in that case. What’s the difference between the two scenarios?

Rachel

Rachel says

Mr Moffat,

I actually figured it out. In example one you essentially subtract the $4000 to get the profit under marginal cost even though it’s positive when calculated. Similarly, you add the 4000 to profit under absorption costing to get to the profit under marginal costing in February even though the 4000 is negative. I hope I got the logic right! Thanks

Rachel