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  6. QUESTION
    A company produces and sells a single product whose variable cost is $6 per unit.
    Fixed costs have been absorbed over the normal level of activity of 200,000 units and have been
    calculated as $2 per unit.
    The current selling price is $10 per unit.
    How much profit is made under marginal costing if the company sells 250,000 units?
    A $500,000
    B $600,000
    C $900,000
    D $1,000,000

    SOLUTION
    Contribution per unit = selling price – variable cost
    = $10 – $6
    = $4 per unit
    Total contribution = 250,000 units × $4 per unit = $1,000,000
    Total fixed costs = 200,000 units × $2 per unit
    = $400,000
    Marginal costing profit = total contribution – total fixed costs
    = $1,000,000 – $400,000
    = $600,000

    Hi, could anyone explain why in marginal costing fixed costs were calcaulated on the basis of budgeted level of activity rather than actual level of activity.
    Its been a long time since i have studied for exams and i cant recall the logic

    Thanks,
    Furqan

    • You must ask this sort of question in the F2 Ask the Tutor Forum, and not as a comment on a lecture.
      The absorption rate is always based on budgeted overheads and budgeted production. Therefore the budget overheads are 400,000. Unless told differently we have no choice but to assume that the actual overheads are the same as the budget overheads.
      I do suggest that you watch all of our lectures – they are a complete course for Paper F2 and cover everything needed to be able to pass the exam well.

      • Thanks John,sorry i didnt know the right forum to ask the question.
        Actually i am studying for f5,i paased f2 a few years ago but than had to take some time away from studies.

        Furqan

  7. Dear Mr. Moffat,
    I have problems with understanding the example 3 from Chapter 9 (comparing the profits under marginal and absorbtion costing). I understood it only arithmetically while doing previous examples, but confused with the logic.
    If Production>Sales, we have closing inventory. Cost per unit by absorbion costing is MORE than cost per unit by marginal costing => we exclude closing inventory amount MORE in absorbtion costing than in marginal costing, therefore, the profit must be LESS in absorbion costing than in marginal costing. But as we calculated from previous examples, profit by absorbtion costing is MORE than profit in marginal costing, when production>sales. I confused about this question and can only learn the rule without clear understanding.
    Could you please explain more detailed this question?
    Thanks in advance,
    Maria.

    • If production > sales, then the inventory will increase over the period.

      Marginal costing charges all of the fixed overheads in the period in which they are incurred.

      Absorption costing charges on what was sold during the period (the cost of goods sold includes only the fixed overheads per unit on the number sold).

      So if the sales are less than production (so inventory increases), then with absorption costing a smaller amount will have been charged for fixed overheads and therefore the profit will be higher.

      If sales are more than production (so inventory decreases) then with absorption costing a larger amount will have been charged for fixed overheads and therefore the profit will be lower than with marginal costing.

  8. Hi,

    I have struggled with working out February and the difference between Absorption and Marginal so I’ve sat down and worked things out and have come to the same answer for both of £81,000? I could just be over thinking this as I expected a difference as with January. Am I right in thinking that there is no difference as there was no closing inventory in February or have I gone completely wrong somewhere in my figures?

    Thanks,
    Laura

    • There is a difference, because what causes the difference is the change in the inventory over the period.

      Have you watched the lecture, because I actually work through the figures for February (and, of course, the answer is also at the back of the lecture notes)?

  9. Dear Sir,

    Could you please help me to understand more clearly in the answer for part b of example 1 .

    Herebelow is my opinions for solution, and I hope You will find out my misunderstand.

    Profit statement

    Juanuary ($) February ($)

    Sales (9.000u x $35) 315.000 (11.500u x $35) 402.500

    Less cost of sales:

    Opening Inv – (2.000u x $25) (50.000)

    Production Cost:
    Material ( 11.000u x $12) (132.000) (9.500u x $12) (114.000)
    Labour (11.000u x $8) ( 88.000) (9.500u x $8) (76.000)
    Varia O/H (11.000u x $5) (55.000) (9.500u x $5) (47.500)

    Less Closing Inv

    (2.000u x $25) (50.000) –

    Less other Variable cost:
    Selling cost: (9.000u x $1) (9.000) (11.500u x $1) (11.500)

    ————– ————-
    Contribution: (19.000) 103.500
    —————- ————-

    Less Fixed cost:

    Fixed production: (20.000) (20.000)
    Fixed selling cost: (2.000) (2.000)

    ———— ———–
    Total net profit $ (41.000) $ 81.500
    ————— ————

    Tks very much, and hope to receiving your reply

    • In January, the cost of sales is (132,000+88,000+55,000) – 50,000 = 225,000.

      Therefore the contribution is 315,000 (sales) – 225,000 (cost of sales) – 9,000 (other variable) = 81,000. (not (19,000) 🙂 )

      You have made the same mistake for February.

      • Dear Sir,

        The formula to calculate the net profit in January will be:

        Net profit in January = Sales – Opening Inventory – Cost of sales – Closing Inventory – other variable cost – Total fiexd cost

        = $315.000 – $0 – $275.000 (132.000+88.000+55.000) – $50.000 – $9.000 – $22.000 (20.000+2.000) = -$41.000.

        Where as: Cost of sale = direct materials + direct labour + variable o/v = $132.000 + $88.000 + $55.000 = $275.000

        Is my formula is correct? If I have any mistake in above formula, Could you please help me to understand more clearly by explaining detailed.

        In your above explain, why thee cost of sales is = $225.000 . Could you help me to understand well of $225.000 because In my views, I think the cost of sales = direct materials + direct labour + variable o/v = $132.000 + $88.000 + $55.000 = $275.000.

        Looking to receiving your reply soon.

        Tks and best regards

      • Firstly you should not learn it just as formulae – the exam deliberately finds ways of testing that you understand, and that you are not simply learning it as rules.

        Secondly, the contribution is sales less cost of sales less other variable costs, we then subtract the fixed costs to get the profit.

        What you have written for the cost of sales is in fact the cost of production. The production is not all sold and so the cost of sales – opening inventory + cost of production – closing inventory.

        Finally, instead of working out all the figure separately, it is much quicker to get the total contribution by simply multiplying the units sold by the contribution per unit. There is enormous time pressure in the exam and you will not have time to calculate all the individual figure as you have done.

        I really do suggest that you watch the lecture again!

  10. 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

    • 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

  11. 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. 🙂

  12. 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.

    • 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.

  14. 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?

    BTW I love your lectures….Thanks for your support.

    • 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.

  15. 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.

    • 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.

  17. 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

    • 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

    • 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

      • 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)

      • 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.

      • 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.

  18. @ 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?

    Thanking you for your response

  20. 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.

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