Marginal Costing

1. 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

• 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

2. says

Hello sir,
I’m having a difficulty in answering these two questions.

Question 1:
A company manufactures a single product which is sold for \$70.00 per unit. Unit costs are:

\$ / Unit
Variable production 29.50
Fixed production 21.00
Variable selling 4.80
Fixed selling 9.00

20,000 units of the product were manufactured in a period during which 19,700 units were sold.
Using marginal costing, what was the total contribution made in the period?

Question 2:
A company manufactures a single product. Unit costs of the product are:

\$ per unit
Variable production 14.75
Fixed production 8.10
Variable selling 2.40
Fixed selling 5.35

400,000 units of the product were manufactured in a period, during which 394,000 units were sold. There was no inventory of the product at the beginning of the period.
Using marginal costing, what is the total value of the finished goods inventory at the end of the period?

Looking forward to the reply. Thank you for the help.

• says

Sorry, but you must ask these questions in the F2 Ask the Tutor Forum – not beneath a lecture.

• says

Okay thank you

3. says

Sir, could you please help me understand over-absorbed & under-absorbed overheads with regard to budgeted &/or absorbed &/or actual Overheads? Getting really confused as to when it is over-absorbed or under-absorbed.
You can explain w.r.t the test question 8.

Thank You.

• says

The fixed overhead absorption rate is based on the budgeted total and the budgeted level of activity. Since the budget (normal) production is 10,000 and the absorption rate is \$12 per unit, the budgeted total must be \$120,000.

In the profit statement the amount absorbed is the actual production multiplied by the absorption rate. Since they actually produced 11500 units, the amount absorbed is 11500 x \$12 = 138,000. The actual total is as budgeted, and so is 120,000.
So the absorbed 18,000 too much – i.e. they over-absorbed.

4. Hello sir John, please I am a bit confused about how non-prodiction cost are absorbed in test question 5 of chapter 7. Kindly clarify please.

• says

The prime cost is materials plus labour (which is 700). Non-production overheads are absorbed at 120% of prime cost which is 840.

• Sir, there was a lecture where u mentioned that non-production
Costs do not form part of cost card. How come it was absorbed here pls.

• says

They do not form part of the cost card to calculate the cost of inventory, but here there is no inventory.
Also, the question specifically says that non-production overheads are to be absorbed.

5. says

Dear Sir,

As per the two method in Feb the difference will be less 4000 (Feb Profit in Marginal Costing Method: 81500- Absorption Costing Method 77500= 4000 More)

It means that in Absorption Costing Method the Closing Inventory is always high valued.

The more accurate way is Marginal Costing method as the inventory is valued at its production cost only and the fixed overhead being charged to PNL correctly.

Can you tell me which is the best way?

• says

There is no best way. The management account does it whichever way is more useful for the decisions he/she is making.

For deciding on a selling price, then absorption costing is more useful – we need the price to cover all the costs if we are to make a profit.
On the other hand, if the selling price is fixed (because of competitors) then marginal costing is useful because we can calculate how many we need to sell to start being profitable (the contribution has to be more than the fixed costs).

Although not relevant for F2, in financial accounting the valuation of inventory has to include all costs of production (including fixed costs) per IAS 2.

6. says

Dear sir,

I have a question that I just don’t understand how it’s resolved:

“A company operates a standard marginal costing system. Last month its actual fixed overhead expenditures was 10% above budget resulting in a fixed overhead expenditure variance of \$36,000.
What was the actual expenditure on fixed overheads last month?”

Thank you.

• says

If the actual figure was 10% above budget, then it means that the variance must have been 10% of the budget figure.

So the budget figure must have been 36,000 / 10% = 360,000.

So the actual expenditure must have been 360,000 + 36,000 = 396,000

(I don’t know if you have watched the lectures on variances yet, because this does need knowledge of variances)

PS You started your question ‘Dear Sir’. If you want me to answer you then it is best to ask in the F2 Ask the ACCA Tutor Forum, then I am sure to see it.

• says

And next time I’ll post my queries in the right place.

7. says

Hi Sir. I’m not able to work out test no 4 which is as follows:

Glossop Limited reported an annual profit of \$47,500 for the year ended 31 March 2000. The company uses
absorption costing. One product is manufactured, the Rover, which has the following standard cost per unit.
\$
Direct material (2 kg at \$5/kg) 10
Direct labour (4 hours at \$6.50/hour) 26
Variable overheads (4 hours at \$l /hour) 4
Fixed overheads (4 hours at \$3/hour) 12
52
The normal level of activity is 10,000 units although actual production was 11,500 units. Fixed costs were as
budgeted.
Inventory levels at 1 April 1999 were 400 units and at the end of the year were 600 units.
What would be the profit under marginal costing?
A \$44,300
B \$45,100
C \$49,900
D \$50,700

• says

The difference between marginal and absorption profits is the change in inventory multiplied by the fixed overheads per unit.

Here, the inventory changes by 200 units. The fixed overheads per unit are \$12, and so the profit will be different by 200 x 12 = \$2,400.

Because the inventory increases, absorption will give the higher profit.

So the marginal profit is 47500 – 2400 = \$45100

• says

Hello Miss NM

What John said is totally right… but I try to remember it in a systematic way that is through a statement like below..

Profit reconciliation statement \$
Profits as per marginal costing xxx
Difference in o.inventory (xx)
Difference in c.inventory xx
Profit as per absorption costing xxx

This is how i do it, i use this format and i’am okay… Maybe Mr. John can correct me or add anything to it..
Miss NM, try it and u’ll see, it works… n it is easy to remember

• says

Gokool:

What you are doing is correct (provided you multiply the difference in inventory by the fixed overheads per unit).

However, many questions do not tell you the amount of the opening and closing inventory – they just tell you the production and the sales, so you know the change in inventory which is all that is needed.

That is why it is safer to learn it the way that I have written it above.

You only need to remember two things:
1) The difference between absorption and marginal profits = the change in inventory x fixed overheads per unit.
2) If inventories increase then absorption gives the higher profit (and vice versa)

• says

dear sir,

I have a question on this basis.
what does it mean by change in inventory?
example, in a question there was an opening inventory of 4000,production was 30000 and sales was 25000.so while calculating for inventory change ,the change in inventory should b 1000 in my sense .but the solution shown that it is 5000.i can not understand y n how they find 5000 as it is closing inventory not the change in inventory.

thank you.

• says

If production is 30,000 and sales are 25,000 then the inventory will change by 5,000 – it will increase by 5,000. So the closing inventory will be 9,000.

If you are asking because the question wants you to calculate marginal profit when you know the absorption profit (or vice versa) then it is the change of inventory (5,000) that matters.

8. Temperance says

@ JohnMoffat

Hi Sir,

If the question just gives you variable non-production costs p.u. are these to be included in the cost card?

Also, if the question just says non-production costs are for eg, \$3 p.u. are these considered fixed non-production costs or not?

• says

Only production costs are relevant in calculating the cost per unit for inventory valuation.

If a question gives a cost per unit then it is a variable cost.

• Temperance says

Oh I see. Noted!Thank you Sir, for the quick response, its quite encouraging:)

9. says

In Chapter 9. Example 3. – Can you please tell me what will be the effect on profit when comparing Absorption Costing against Marginal Costing, if Production = Sales?

• says

The profits will be the same (because the level of inventory will not change).
This is covered in my lecture.

10. says

Many thanks John Moffat for you lectures. May I ask you for some help please as I’m stuck.

The question is : B Co makes a product which has a variable production cost at \$21 per unit and a sales price of \$39 per unit. At the beginning of 20X5, there was no op.inventory and sales during the year were 50,000 units. Fixed costs (production, administration, sales and distribution) totalled \$328,000. Production was 70,000.

The value of closing inventory is \$ ?

Solution:

The contribution per unit is \$39-\$21 = \$18

Closing inventory volume = 70,000 units – 50,000 units = 20,000 units
Value of closing inventory = 20,000 units x \$18 = \$360,000

My question is: shouldn’t we use absorption costing as Production > Sales therefore closing it will give us a higher profit. Why marginal costing if we haven’t been told and in my opinion Absorption is the right one.

• says

Sorry I got it now. Marginal costing is the only solution here.

Thank you anyway