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If inventory levels decrease, absorption costing will report a lower profit than marginal costing because as well as the fixed overhead incurred, fixed production overhead which had been brought forward in opening inventory is released and is included in cost of sales.
What does that mean? Can someone help me by giving me an illustration?
This is just the converse of the statement that if inventory levels increase, absorption costing will report a higher profit than marginal costing.
Look at the worked example – no opening inventory – closing inventory 60 units (220 – 160) i.e. inventory level has increased. (d) shows that AC is 400 and (e) shows that MC is 280.
Opening inventory is part of the cost of goods sold (expense) and closing inventory carries forward costs to the next period (asset). If you carry forward more cost than you brought forward profit will increase – if less, profit will decrease.Can you give me a full example with the fixed production overhead? I can’t understand your reply very well.
Thank you.
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