1. avatar says

    If we have over charged by 2000, we would reduce our costs, thus increasing profits by 2000. But I am confused that why are we not reducing the value of our closing stock? i.e. 2000 units would be costing less than before because each unit is now costing less as we are producing more. Wouldn’t it be misleading if we still value closing stock at 54000 although it costs less?

    • Profile photo of John Moffat says

      If we were preparing financial accounts at the end of the year, then what you have said would be true.

      However we are preparing management accounts which are normally prepared monthly. Some months we will produce more units than expected, but some months we will produce less units. It will be silly to keep changing the inventory value every month simply because we produce a few more or a few less. So we continue to value the inventory every month at the average we expect over the year – i.e. at the standard cost.

      (In practice we can do whatever we like – there are no rules for management accounting in real life. If there was a good reason for changing the inventory value then we could. However, for Paper F2 certainly we always value inventory at the standard cost.)

      PS It has not been called stock for some time now. The correct name is inventory.

  2. Profile photo of camita says

    Good evening,

    When the question given variable selling cost and fixed selling cost then asked you to do a absorption and marginal statement……should u add both to work out the total selling price? Really want to know, thanks

  3. avatar says

    Dear Sirs,

    thank you very much for sharing these lectures – i’m fascinated by your consistent style of delivering the subject which makes our life much easier.

    Please excuse my ignorance, but I find it difficult to understand why did we reduce the production costs by closing inventory of 54000 (27$*2000 units) in January’s statement. It increases the profit for January, but actually in real life we’d still have to spend the money to produce those extra 2000 units which would reduce the profit for that month i suppose… Can you please comment on this point as I seem to be missing something here.

    Thank you very much for your time and effort!

    Kind regards,

    • Profile photo of John Moffat says

      In the profit statement (for financial accounts as well as for management accounts) we are trying to show the profit made on what was sold.

      To do this we subtract from the sales figure, the cost of what was sold.
      The cost of what was sold is the cost of production less the cost of any closing inventory.

      Here is an extreme example.

      Suppose the company spent $12,000 producing goods in January. Suppose that is all that they produce all year, and they sell $1,000 of them each month at a selling price of $1,500.

      We do not say that in January they make a loss of $10,500 (1500 – 12000) and then they make a profit of $1500 a month for the rest of the year. That would be ridiculous.

      In January, the sale are $1,500 and the cost of what was sold is $1000 – the profit is $500 for January (and is $500 each month).

      • avatar says

        thank you, Sir, I now understand that we subtracted the closing inventory in January as it wasn’t sold then and was sold in February.

        The example was also informative, much appreciated.

  4. avatar says

    May I ask why would we do an absorption calculation on a “budgeted” fixed production overheads of 20,000 (calculating it as 22,000 due to over-manufacturing), but not do the same for fixed selling costs of 2000?. perhaps I don’t understand why we can play with the fixed costs of production, but leave the same fixed costs of selling the way they are…

    • Profile photo of John Moffat says

      It is because the total variable overheads will change with the number of units produced, whereas the total fixed overheads should not change by definition (which is why we need to adjust by the over or under absorption)

  5. avatar says

    Why there are no selling costs in the cost card now that there is no difference between actual selling costs and budget selling costs?
    I mean, what’s the meaning to make a cost card without selling costs? What’s meaning of calculating the gross profit?
    What information can the gross profit bring to the manager, and what is the different information the net profit can give?

    • Profile photo of John Moffat says

      There are a few points here.

      Firstly, remember that there are no ‘laws’ about management accounts and so the management accountant can present the information in whatever way that they feel is most useful for the particular company. The two main ways are absorption costing and marginal costing. Marginal costing is the next chapter and to a large extent deals with the point that you are making.

      However their are advantages and disadvantages with both approaches.

      One reason that some management accountants prefer absorption costing is that it is closer to what is required in financial accounting. Accounting standards state that inventory must be valued at cost of production (all costs of production but not including any other costs, such as selling costs). The standards also require that gross profit and net profit are both shown in the financial statements. Again, the management accounts are not covered by the accounting standards, but obviously it makes life maybe a bit easier for the management accountant if they produce the monthly accounts in a similar way to the yearly financial accounts.

      Another point is that there will be different managers involved. It will be the job of the production manager to worry about the costs of production, another manager will likely be responsible for controlling selling costs, another for admin costs etc.

      Finally, when determining a selling price, clearly all costs will need considering – as you will see in the next chapter, marginal costing takes a different (and arguably better) approach although there is a problem as to how to deal with fixed costs.

      Hope that goes some way towards answering your question :-)

    • Profile photo of John Moffat says

      If overheads have been over-absorbed it means that too much has been charged for overheads.
      So, to get the correct profit we need to reduce the overhead expense – and a lower expense means a higher profit.

      (the other way round obviously if we have under-absorbed)

    • Profile photo of John Moffat says

      We are preparing budget profit statements and therefore the total fixed overheads should be 20,000 (by definition, they should not change with the level of production).

      However, we are charging them at the rate of $2 per unit (on the cost card) and since we are budgeting on producing 11,000 units in January it will mean that we are effectively charging 11,000 x 2 = $22,000 for fixed overheads.

      This is 2,000 more than it should be and so we have over-charged (or over-absorbed) the overheads. To get the correct profit we need to reduce the overhead expense by 2000 which means that we need to increase the profit by 2000.

  6. avatar says

    dear sir,
    i have understood what u have told thoroughly [better than my tutors] ,thank you so much , but my doubt is that :
    my tutor told me that in absorption costing only variable costing is included. but in marginal ,both both variable n fixed is charged. but you have charged both in the profit statement .
    [ p.s. the example illustrated by my tutor was similar to yours ]

    • Profile photo of John Moffat says

      I am afraid that either you misheard your tutor, or your tutor was wrong!

      In both marginal and absorption profit statements we do charge all the overheads (variable and fixed), but in marginal costing only variable costs are included in the cost per unit, whereas with absorption costing both variable and fixed overheads are included in the cost per unit.

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