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25,000 units of a company’s single product are produced in a period during which 28,000 units are sold. Opening inventory was 7,000 units. Unit costs of the product are:
$ per unit
Direct costs
16.20
Fixed production overhead
7.60
Fixed non-production overhead
2.90Differences in profit between TAC and MC are always caused by the valuation of opening and closing inventory. For example, the higher the value of closing inventory, the higher the profits:
Cost of sales = Opening stock + Purchases – Closing stock
If closing stock goes up, cost of sales goes down and profit (Sales – Cost of sales) goes up .
Similarly, the higher the value of opening stock, the lower the profit.
Here, the closing inventory at the end of the transactions must be: 7,000 + 25,000 – 28,000 = 4,000. Inventory has fallen from 7,000 to 4,000 ie by 3,000.
Fixed production costs of $7.60 are in inventory under TAC, but not under MC
The difference in profit is therefore 3,000 x 7.60 = 22,800 [Profit will fall by this if you move from MC to TAC].
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