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Question:
A new company has set up a marginal costing system and has a budgeted contribution for the period of $ 26,000 based on sale of 13,000 units and production of 15,000 units. This level of production represents the firm’s expected long term level of production. The company’ s budgeted fixed production cost are $ 3,000 for the period.
If the company were to change to an absorption costing system the budgeted profit would be:
My working:
Absorption rate 3,000/15,000 = $ 0,2
Budgeted contribution $ 26,000
+ Closing inventory
2000 (15000-13000)*0.2 $ 400Profit under absorption costing $26,400
For my knowledge budgeted contribution is equal selling price – total variable cost.
Answer gives in the book.
Absorption rate 3,000/15,000 = $ 0,2
Budgeted profit with marginal costing: Contribution – fixed cost = $26,000 – $3,000 =$23,000
i understand until here.
+ Closing inventory
2000 (15000-13000)*0.2 $ 400Total $23,400.
why do we have to add closing inventory to calculate the profit under absorbtion costinf system ?
As I explain in my free lectures on absorption and marginal costing, the only difference ever. between the absorption and marginal profits is the change in inventory multiplied by the fixed production cost per unit (because inventory is valued different in the two methods).
Here the marginal profit is 26,000 – 3,000 = 23,000.
The fixed production absorption rate is 0.20 per unit.
The inventory is increasing by 15,000 – 13,000 = 2,000 units.
Therefore the absorption profit is higher than the marginal profit by 2,000 x 0.20 = $400.
Again I do suggest that you watch my lectures on this where I explain why this is the case.
The lectures are a complete free course for Paper MA and cover everything needed to be able to pass the exam well.
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