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Dear John sir please consider this,
Company uses absorption costing to value inventory. It’s fixed overhead absorption rate is £12per labour hour each unit of production should take 4hrs.in recent period there was no opening inventory. 20000 units were produced using 100000 labour hours.18000 units were sold.actual profit was £ 464000.what would be the profit if standard marginal costing was used?sir the answer given was 368000.but my answer was 344000.the thing what I don’t understand is that in valuing closing inventory what should be the oar £12per labour hour or £48per unit?the publisher had stated that the reason for me to get 344000(wrong answer) is that I’ve valued inventory on basis of actual labour hours in a standard absorption costing system.so why oar * actual hours wrong?The only difference ever between absorption profit and marginal profit is due to the fixed overheads in inventory.
The difference is the change in inventory x fixed overheads per unit.There the inventory changes by 2,000 units (produce 20,000 and only sell 18,000).
The fixed overheads are $12 per hour, therefore 4 x $12 = $48 per unit.
Therefore the profit is different by 2,000 x $48 = $96,000.In standard costing, inventory is always valued at standard cost (using the standard absorption rate). The reason for it is the in practice profit statements will be prepared monthly and we do not change unit inventory values every month simply because some months we produce more and other months we produce less.
I do suggest that you watch our free lectures on this. Our lectures are a complete course for Paper F2 and cover everything needed to be able to pass the exam well.
I did watch it & completed the textbook of o.t.But I think I should watch it again.thank you sir for clarifying the issue in the above question.
Sir, could you please explain this question again. I mean, I can’t understand what happens with this difference of 20,000 hours? Because we had to have 80,000 hours incurred (20,000*4) but we incurred 100,000. Did we make any adjustments for this before we arrived at a profit of 464,000$? I am just interested how would we account for this difference.
Sorry for bothering you! 🙁But why would we want to make an adjustment? You would not expect the actual costs to always be exactly the same as the standard costs.
However it is irrelevant for the question anyway because you are given the actual profit using absorption costing and asked just to state what the profit would be using marginal costing. It is testing the important fact that the only difference is the change in inventory multiplied by the standard fixed overheads per unit.
Again this is all explained in my lectures on marginal and absorption costing.
Am, yeah I watched the lectures and read the textbook (BPP) and did the exercises. I understand the difference between marginal and absorption costing. I was just wondering about these excess hours, because for example in my text book they had an example where they showed the difference between marginal and absorption costing and at the same time the overheads in that example were undervalued. So they adjusted the undervalued overheads and then showed that the difference between marginal and absorption costing is due to the difference in inventory levels.
That’s why I was curious whether here they did the same ( accounted the overheads for that excess 20,000 hours before arriving to the profit of 464,000$ using absorption method). I hope you understand my point. Thank you for your answer!
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