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A company has the following budgeted costs and revenues :
$/unit
sales price : 50
Variable production cost 18
Fixed production cost 10In the most recent period, 2,000 units were produced and 1,000 units were sold. Actual sales price, variable production cost per unit and total fixed production costs were all as budgeted. Fixed production costs were over-absorbed by $4,000. There was no opening inventory for the period.
What would be the reduction in profit for the period if the company has used marginal costing rather than absorption costing?
(A) 4,000
(B) 6,000
(C)10,000
(D)14,000—————————————————————————————-
My workings:
Marginal costingSales 50,000
Less: cost of sales
opening 0
production cost 36,000
($18*2000 units)
less closing inventory 18,000Contribution 32,000
Less: Fixed production cost (20,000)Net profit 12,000
——————————————————————————————–
Absorption CostingSales 50,000
Less: cost of sales
opening 0
production cost 56,000
($28*2000 units)
less closing inventory 28,000
less over-absorption (4,000)Net profit 26,000
Reduction in profit = 26,000- 12,000 = 14,000
The correct answer is (C), I don’t understand, seeking help, thanks!
Just some thoughts of mine.
First of all, in absorption costing, you need to add closing inventory in order to get absorption costing profit = $22000 (50000 – 56000 + 28000). Then you can get the right answer is (C) $10000. Example 1, part b in the free video (chap 9) lecture did demonstrate this.
Secondly, over/under-absorption costing does not affect the difference in profit between marginal and absorption costing. (I got this from the answer in BPP kit :D)
I hope I made myself clear to you.
Look forward to the reply from Mr Moffat.
Two things:
Firstly the budgeted fixed overheads must have been 2,000 x $10 = 20,000 (the amount absorbed) less 4,000 (the over-absorption) = 16,000. Since the actual fixed overheads were the same as the budgeted overheads, you should have used $16,000 when calculating the marginal profit which is then 16,000. This is reduction of 10,000 as against the absorption profit.
Secondly, to calculate both profits is wasting time (and time is short in the exam). The difference between the marginal and absorption profits is only ever the change in inventory multiplied by the fixed costs per unit. Since the produced 2,000 and sold 1,000, the inventory increases by 1,000 units. Therefore the absorption profit is higher by 1,000 x 10 = 10,000.
I do suggest that you watch the free lectures on marginal and absorption costing where this second point is stressed.
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