The Management Accountant’s Profit Statement – Marginal Costing

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1 Overview

Some businesses only want to know the variable cost of the units they make, regarding fixed costs as period costs. The variable cost is the extra cost each time a unit is made, fixed costs being effectively incurred before any production is started.

The variable production cost of a unit is made up of:

	$
Direct materials	X
Direct labour	X
Variable production overheads	X
Marginal cost of a unit	X

Marginal costing

Variable production costs are included in cost per unit (i.e. treated as a product cost).

Fixed costs are deducted as a period cost in the profit statement.

2 Contribution

Contribution is an important concept in marginal costing. Contribution is an abbreviation of “contribution towards fixed costs and profit”.

It is the difference between selling price and all variable costs (including non-production variable costs), usually expressed on a per unit basis.

		$	$
Selling price:			X
Less:	Variable production costs	X
	Variable non-production costs	X	(X)
Contribution		X	X

Note: Contribution takes account of all variable costs. Marginal cost takes account of variable production costs only and inventory is valued at marginal cost.

X plc produces one product – desks.

Each desk is budgeted to require 4 kg of wood at $3 per kg, 4 hours of labour at $2 per hour, and variable production overheads of $5 per unit.

Fixed production overheads are budgeted at $20,000 per month and average production is estimated to be 10,000 units per month.

The selling price is fixed at $35 per unit.

There is also a variable selling cost of $1 per unit and fixed selling cost of $2,000 per month.

During the first two months, X plc expects the following levels of activity:

	January	February
Production	11,000 units	9,500 units
Sales	9,000 units	11,500 units

All other results were as budgeted.

(a) Prepare a cost card using marginal costing

(b) Set out Profit Statements for the months of January and February.

(a) Cost card

	$ p.u
Materials (4kg × $3)	12
Labour (4hrs × $2)	8
Var. overheads	5
Marginal cost	$25	p.u

Selling price	$35	p.u
Marginal cost	(25)
Variable selling cost	(1)
Standard profit	$9	p.u

(b) Income Statements

		January		February
Sales	(9,000 × $35)	315,000	(11,500 × $35)	402,500
Less: Cost of sales:
Opening inventory		–	(2,000 × $25)	50,000
Materials	(11,000 × $12)	132,000	(9,500 × $12)	114,000
Labour	(11,000 × $8)	88,000	(9,500 × $8)	76,000
Variable o/h	(11,000 × $5)	55,000	(9,500 × $5)	47,500
		275,000		287,500
Less: Closing inventory	(2,000 × $25)	(50,000)		–
		225,000		287,500
		90,000		115,000
Less: Variable selling costs	(9,000 × $1)	(9,000)	(11,500 × $1)	(11,500)
Contribution		81,000		103,500
Less: Fixed costs
Production		(20,000)		(20,000)
Selling		(2,000)		(2,000)

Actual Net Profit		$59,000		$81,500

Prepare a reconciliation of absorption and marginal costing profits

	January	February
Absorption costing	63,000	77,500
Marginal costing	59,000	81,500
Difference	4,000	(4,000)

Fixed overheads in inventory value:

Opening inventory (2,000 × $2)	–	(4,000)
Closing inventory (2,000 × $2)	4,000	–
	4,000	(4,000)

	January	February
	$	$
Absorption costing
Marginal costing
Difference

The difference in profit arises from the different inventory valuations which are the result of the difference in treatment of the fixed production overheads.

Effects

The delay in charging some production overheads under absorption costing leads to the following situations.

Compare profits under marginal and absorption costing for the following situations

(a) Production > Sales

(b) Production < Sales

(c) Production = Sales

Answer the questions one at a time. Your progress is saved so you can leave and come back.

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