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June 24, 2020 at 7:09 am
I know this Q sounds like one of those you already answered. But I bear with me for a sec. I wrtite down the calculation a tad differently. Let’s assume with start with the direct costs. So our margin would be 35-25 = 10 per unit. No fixed production OH yet included. We get contribution margin 10 * 11 000 = 110 000 Sold during Jan | Went to the inventory 9000 units | 2000 units $ 90 000 | $20 000 Now to arrive at 74 000 of profit for Jan what we do is: Less: 22 000 * 9/11 | 22000 * 2/11 Equals 72 000 | 16 000 And plus over-absorption 2000 74 000 | 16 000
Hence my Q is: Why do we adjust for overabsorption in Jan only for the whole amount? Even though partly Fixed OH are included in the closing inventory. Wht don’t we charge over/under absorption prorata depending on the amount of inventory rolling to the next month?
Image the situation when we only sold 200 units this month and the rest would go to the inventory. It means we would have been left with $1600 before adjustments but then we would boost our profit by $2000 adjustment to $3600. And the inventory would be valued 86400.
Please, correct me at the point where my judjement is flawed
John Moffat says
June 24, 2020 at 9:38 am
If we produced the budgeted amount each month then the problem would not exist. However from month to month, some months we will produce more and some months we will produce less. So we make the adjustment for the over or under absorption. In the long term it makes no difference – in the long term the total profit will stay the same whether we use absorption or marginal costing.
June 26, 2020 at 10:05 am
Hi John. Thank you for your reply.
I get your point. However I was trying to stress another point. I totally understand that if we produced the budgeted amount, there would be no problem at all. And since our production levels will always diverge, I understand that we have to make adjustments. But my Q is why are we adjusting for over/under in one month for the whole amount even though we were left with some goods in the inventory and it seems these goods should bear some of the adjustment? I mean it would seem logical to distribute it this way: Jan for 9/11*2000 and Feb for 2/11 * 2000. Having decreased the cost of inventory, we would end up with profit adjusting up 9/11*2000 in Jan and 2/11*2000 in Feb. Does my Q make sense now? Many thanks in advance. Just struggling with this part. As I personally make adjustments for the companies I advise in exactly this way.
June 26, 2020 at 2:27 pm
But then we would be valuing inventory at a different unit cost each month. Although certainly we can change the inventory value each month – in management accounting we can do whatever we find most useful – it is more common (and certainly always in the exam) to keep to the same standard cost for inventory throughout the year. Also when we come to variance analysis (later in the course) it makes checking whether we have paid too much or too little for materials etc purchased each month more meaningful. (For financial accounting we have to value the inventory at actual cost, but that is not relevant for management accounting.)
May 3, 2020 at 3:13 pm
Mr. Moffat , is there any way you could have the subtitles on the video lecture better written as they are wrong & very hard to refer back to when I miss certain words that you say during the lectures.
if the software team could have a look at it , it would be of great help.
Great lecture as always !
July 6, 2020 at 2:53 pm
When you click the subtitles button it states that they are auto generated in brackets, so I am assuming it means these are generated by Youtube?
April 22, 2020 at 2:42 pm
Good afternoon Sir
At the begining I would like to say that you are a wonderful person and you helped me a lot during preparing for FA.Thank you very much.
I have a doubt about adjustment of over/under absorption. Why in January we don’t take into consideration absorption included in closing inventories? Accually when we calculate cost of sales we deduct absorption of overheads included in closing inventories and there would be 22000 minus 4000 = 18000 and underabsorption?
April 6, 2020 at 12:05 pm
Hello, In example 1 why have we taken actual fixed overhead at 20000 for calculating over absorption as in question it is mentioned that fixed production overhead are budgeted at 20000 instead of actual?
April 1, 2020 at 10:53 am
In example 1, why did we not include opening inventory and closing inventory for February calculation?
April 1, 2020 at 4:14 pm
It is because we only look at the cost of goods that were sold, as we should do.
By all means calculate the cost of the goods sold by taking the opening inventory plus the production less the closing inventory (and you can see it done this way in the printed answer in the lecture notes), but it takes longer 🙂
March 8, 2020 at 11:16 am
Hi John,thanks for the lecture. I had a doubt regarding the way we charged fixed selling cost. We had first taken fixed selling cost into account while calculating fixed overhead per unit that’s how we reached the figure of $2 per unit(22000/11000) So why did we deduct it again from the final profit along with variable selling cost? Wouldn’t it be liking charging fixed selling cost of 2000 twice ?
March 8, 2020 at 12:51 pm
The $2 per unit does not relate to the selling overhead.
It is the fixed production overhead per unit, absorbed at the rate of $20,000/10.000 = $2 per unit.
March 9, 2020 at 4:18 pm
January 30, 2020 at 2:34 pm
Sir near time stamp 12:56 shouldn’t it be actual fixed OH occurred= 22000 and absorbed O.H =20000?
January 30, 2020 at 2:40 pm
and shouldn’t it be underabsorption?
January 30, 2020 at 2:52 pm
No worries sir I got it.Great lecture btw
November 27, 2019 at 7:16 pm
for example 2 since we are calculating the absorption rate for the actual hours, can we use the actual hrs (78000) and actual fixed OH (315000)to solve the OAR or will that change the answer?? and in other examples, is that applicable as well?
November 14, 2019 at 6:26 am
sir, thank you so much. but I have a question. why should we use 27 dollar per unit to calculate the value of inventory? or why the fixed average overheads on the inventory is 2 dollar per unit?
November 14, 2019 at 8:46 am
We are not preparing financial accounts – we are preparing management accounts. They are usually prepared each month and we don’t want to change the value of inventory each month. We absorb the fixed overheads based on what we expect (on average) to happen, and value the inventory accordingly.
October 4, 2019 at 11:28 am
at 17:16 you said that the sales are 115000 when in the question it says 11500, that is why 92000 is wrong and people are getting confused
October 4, 2019 at 6:07 pm
What I have written on the screen is completely correct.
If you want to see how the profit is arrived at showing a full profit statement, then this is of course printed in the lecture notes (in the answers to examples).
People are not getting confused!!
October 5, 2019 at 10:21 am
Sorry sir I thought you wrote 115000, when instead you wrote 11500u, I thought the u was a zero. This topic was a little tricky, but at the end I got the hang of it!
October 5, 2019 at 1:24 pm
That’s great – I am pleased you have got the hang of it 🙂
September 4, 2019 at 1:46 pm
Very confused how you came to the figure for February
Sales: £35 x 11,500 = £402,500
Material 9500 x 12 = 114,000 Labour 9500 x8 = 76,000 Var Prod. 9500 x5 = 47,500 Fixed Prod. 9,500 x2 = 19,000
Total = £256,500
No remaining inventory. 0
Budgeted profit. £146,000
Under Absorb £1,000
Still comes no where close to your figures. ???
September 4, 2019 at 1:56 pm
Okay. £54,000 opening inventory from previous month.
September 4, 2019 at 10:13 pm
December 17, 2019 at 9:57 pm
I’m also very confused Total=256,000 Less inventory=£54,000 Profit will be £402,500-£202,500= 200,000 This is nowhere near the actual profit Somebody help please
December 18, 2019 at 8:00 am
The 11,500 units sold in February were the 2,000 units that were in inventory at the start of the month plus the 9,500 units that were produced during the month. The cost of the 2,000 units at the start of the month was $54,000, the cost of the 9,500 units produced during the month was $256,500. So the total cost was $310,500, and the profit is therefore 402,500 – 310,500 = $92,000.
September 3, 2019 at 11:37 am
I’m having trouble identifying whether the overheads were over-absorbed or under-absorbed could you explain me that
September 3, 2019 at 1:50 pm
The overheads absorbed is the production multiplied by the standard fixed overhead per unit.
If this is more than the actual overheads then there is over-absorption. If this is less than the actual overheads then there is under-absorption.
August 23, 2019 at 1:19 pm
Thanks for clarifying that.
August 23, 2019 at 2:17 pm
You are welcome 🙂
August 22, 2019 at 8:17 pm
With regard to example 1 , why are we making an adjustment of £2,000 for the over absorption which relates to the production of 11,000 units when we are trying to calculate the profit figure for only 9,000 units.
If 9,000 units are sold we have absorbed £18,000 of the fixed production cost. Therefore we have under absorbed by £2,000. Thanks
August 23, 2019 at 9:38 am
If they produce 11,000 units then the fixed overhead charged (absorbed) will be 11,000 x $2 = $22,000.
(The amount absorbed depends on the production. Although only 9,000 units are sold, the cost of sales is the cost of the 11,000 produced less the cost of the closing inventory of 2,000 units.)
Given that $22,000 has been absorbed, we have over-absorbed by $2,000.
June 1, 2019 at 12:29 am
Sir, I would have loved if worked February the long way…I’m not seeing how you arrived at a profit of 92,000, but I’m assuming it has something to do with the opening inventory
June 1, 2019 at 11:54 am
The answer in the lecture notes show it the ‘long way’ (although you won’t have time to do it that way in the exam 🙂 )
March 7, 2019 at 8:00 am
March 7, 2019 at 12:34 am
Thank you so much. 🙂
March 6, 2019 at 11:58 am
calvintai: The difference is that in Example 1 we are asked to prepare budget statements and therefore we are using the budgeted fixed overheads of 20,000. To get the over/under absorption we then compare that with the absorbed overheads (the actual production x the standard fixed overheads per unit).
In Example 2 however, we are not prepared a budget. We know what the actual fixed overheads are (315,500) and we are comparing this with the absorbed overheads (again the actual hours x the standard fixed overheads per hour).
March 6, 2019 at 9:33 am
Hi, I am so confused on the Over/Under Absorption. On example 2 Why you use the budgeted fixed production overhead $20,000 as Actual fixed overhead, but you used the $315,500 as the actual fixed overhead? Why not 320,000? It would be so thankful if someone can answer my question.
June 23, 2019 at 10:02 pm
I was thinking the same thing, glad you asked and glad the Tutor cleared it up.
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