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A company manufactures and sells a single product. In two consecutive months the following levels of production and sales (in units) occurred:
Month 1 Month 2
Sales 3,800 4,400
Production 3,900 4,200
The opening inventory for Month 1 was 400 units. Profits or losses have been calculated for each month using both absorption and marginal costing principles.13. Which of the following combination of profits and losses for the two months is consistent with the above data?
Absorption costing profit/(loss) Marginal costing profit/(loss)
Month 1 Month 2 Month 1 Month 2
$
A. 200 4,400 (400) 3,200
B. (400) 4,400 200 3,200
C. 200 3,200 (400) 4,400
D. (400) 3,200 200 4,400The correct answer is C.
Month 1: production > sales Absorption costing > marginal costing
Month 2: sales > production marginal costing profit > absorption costing profit
A and C satisfy month 1, C and D satisfy month 2; therefore C satisfies both.
I have watched the lecture and I’m aware that When production is more than sales that absorption costing gives higher profits.
But in this case, although the production is more than sales in month 1, there are 400 units of opening inventory, thereby, change in inventory = 100-400 = -300. As the inventory level is falling, the marginal profits should be higher than the absorption profits and not the other way around as in the answer. Am I correct?
No.
In month 1 the they are producing 100 more units then they are selling. So the inventory will increase by 100 units and will therefore be 500 units at the end of the month.
Given that the inventory is increasing, the absorption profit must be higher than the marginal profit.
Sorry for the late response. I had been preparing for my university semester exam. It got over today.
Thank you. I have understood.
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