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If there is a change in inventory levels then there will be closing inventory that needs to be adjusted in flexed budget.
Closing inventory is the difference between how many units were produced and how many units are sold. If we produce more units in the period than the units sold then we have inventory left at the year-end which we couldn’t sell and it needs to be less from the total production costs because they do not relate to the current period rather they would be accounted in the next year when they are being sold.
Closing inventory is calculated as:
Closing inventory = (Production units – Units sold) x Total Production costsClosing inventory should be deducted from the Total costs to get the Total Production costs in both marginal or absorption costings.
Am i correct?
What you have written is not correct.
The difference between the units produced and the units sold gives the change in the inventory (i.e. the difference between the opening inventory and the closing inventory).
The cost of sales is the opening inventory plus the cost of production less the closing inventory.
With absorption costing, the valuations of the inventories and the calculation of the cost of production include all production costs (including fixed production costs). With marginal costing we do not include fixed production costs, only the marginal/variable costs.
I do explain all of this in my free lectures on absorption and marginal costing.
Sorry, I forgot to mention that.
In Absorptional costing closing inventory is calculated as:
Closing inventory = (Production units – Units sold) x Total Production costs[Total Production costs includes all variable and fixed costs]
In Marginal costing closing inventory is calculated as:
Closing inventory = (Production units – Units sold) x Total Production costs[Total Production costs includes all variable but not fixed costs at all]
I hope it is correct now? 🙂
Not quite!
As I wrote in my previous reply, the difference between the units produced and the units sold gives the change in the inventory (i.e. the difference between the opening inventory and the closing inventory). If the produce more than they sell then the inventory will increase, whereas is they sell more than they produce then the inventory will decrease.
BUT in chapter 13 example 1 of the basic variance we had budgeted production of 8,700 units and budgeted sales 8,000 units and the difference is the closing inventory of 700 (i.e. not change in inventory as u said before – so I am confused here) multiplied with the total production cost of $68. (and this is what you have done in the lecture)
As we can see that fixed cost is included in the total production cost therefore the company is using absorptional costing (I hope I am correct here?)
It certainly is the change in the inventory!!!!!
The question specifically says that the opening inventory is zero. If it changes by 700 then the closing inventory will be 700.
Yes, they are using absorption costing for the reason you state.
I do explain both your questions in my free lectures working through this example. It is pointless to use the notes without watching the lectures because they are only lecture notes (not a Study Text) and it is in the lectures that I work through the examples and explain and expand on the notes. The notes by themselves are not enough to be able to pass the exam, and if you are not watching the lectures for any reason you need to buy a Study Text from one of the ACCA Approved Publishers and study from there.
Thank you very much 🙂
It was really helpful. But lastly please state the following too.
Whenever there is a change in inventory then we will always be given opening inventory in the question so that we can calculate closing inventory otherwise the change in inventory has no other use in our budgeting calculations!
For eg if we have change in inventory of 700 but there is no opening inventory at all then change in inventory should not be included and it would be silly for examiner to not give opening inventory when there change in inventory. (true?)
It all depends what the question is asking. Certainly if in any question it is required to calculate the closing inventory, then you would certainly be told the opening inventory.
In relation to variances, then as I state in the lecture you could not ever be asked a full question on basic variances because they are examined in Paper MA (was F2). However it is important to revise basic variances partly because small extracts may be asked but more importantly the understanding of them is necessary for the advanced variances which are examined a lot in Paper FM.
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