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Predetermined absorption rate is used in absorption costing because we are unable to know the actual cost of some overheads until the end of the period but production is continuous. As we know, overheads are divided into variable and fixed overheads so is it mean that we will have two predetermined rate established, one for variable and the other for fixed overheads?
Next, why marginal costing does not use predetermined rate? marginal costing do take variable overhead into account and we are unable to know the amount of variable overhead that will be charged at the end of one period also.
Both marginal and absorption costing use a pre-determined rate based on the budgeted figures.
Marginal costing uses the variable cost per unit whereas absorption costing also includes the absorbed fixed production cost per unit.
Have you watched my free lectures on this?
Yes, I have watched them but no emphasis put on this.
Since Marginal costing also using a predetermined rate, why will it not have the problem of over/under-absorbed?
Because with marginal costing we do not absorb the fixed overheads but just charge whatever the actual fixed overheads are. (And this is certainly emphasised in the lecture!)
How is this question solved?
A clothing manufacturer makes a specific brand of jeans which it sells at a standard price of $100 per pair. The manufacturer’s costs are as follows.
Standard variable production cost: $16 per pair
Total fixed production cost per month: $240,000 (10,000 pairs are planned to be produced per month) Total fixed non-production costs: $300,000 per month
In Month 1, when the opening inventory is 1,000 pairs, production of 10,000 pairs is planned and sales of 8,000 pairs are expected.
In Month 2, sales are planned to be 9,000 pairs and production is still 10,000 pairs.
Required
(a) What would be the net profit for Months 1 and 2 under
(i) Absorption costing
(ii) Marginal costing
(b) What comments could you make about the performance of this business?
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