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[ F5 ] The difference between absorption costing and marginal costing

  • 2012年11月13日 17:59 
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摘要:The difference between absorption costing and marginal costing              ......
The difference between absorption costing and marginal costing       
                                     ----Relevant to Paper F5
 
        Absorption costing is a method of product costing which aims to include in the total cost of a product (unit, job, and so on) an appropriate share of an organisation’s total overhead, which is generally taken to mean an amount which reflects the amount of time and effort that has gone into producing the product. In other words, absorption costing is a mean of incorporating a fair share of these costs into the cost of a unit of product or service provided.
 
        Product costs are built up using absorption costing by a process of allocation, apportionment and overhead absorption. The first stage of overhead apportionment involves sharing out (or apportioning) the overheads within general overhead cost centers between the other cost centers using a fair basis of apportionment (such as floor area occupied by each cost center for heating and lighting costs). The second stage of overhead apportionment is to apportion the costs of service cost centers (both directly allocated and apportioned costs) to production cost centers. The final stage in absorption costing is the absorption into product costs (using overhead absorption rates) of the overheads which have been allocated and apportioned to the production cost centers.
 
        Marginal costing is an alternative to absorption costing. Only variable costs (marginal costs) are charged as a cost of sales. Fixed costs are treated as period costs and are charged in full against the profit of the period in which they are incurred.
 
        When we calculate the profit using different method, the answers are not the same. An example can illustrate:
 
Example:
Selling price per unit                          $10
Variable costs per unit    
     Direct materials                             $2
     Direct labour                                  $3
     Production overhead                     $1
     Selling and distribution                  $1
Fixed costs:
Production: budgeted                         $8,000
          Actual                                        $8,500
Selling and distribution:
(budged and actual)                            $2,000
 
Activity levels:
                                              Year 1                 year2
                                               Units                  Units
Budgeted production             4,000                  4,000
Actual sales                           4,200                  4,000
Actual production                   4,400                  3,800
 
There is no opening inventory in year 1.
 
Required:
Prepare an income statement under absorption costing for years 1 & 2.
Prepare an income statement under marginal costing for year 1 & 2
 
Using absorption costing:
                                                  Year 1                Year 2
                                                     $                       $
Sales                                        42,000               40,000
 
Cost of sales:
     Opening inventory                                          1600
Production:
     Variable costs                      26,400               22,800
     Fixed costs                            8,800                 7,600
 
Closing inventory                       (1600)                   
(over)/under absorption              (300)                900
Gross profit                                  8,700              7,100
Variable selling & distribution     (4200)              (4,000)
Fixed selling & distribution         (2,000)              (2,000)
Net profit                                     2500                 1100
 
Workings :
1.  OAR= $8,000/4000=$2/unit
2.                                                 year1       year 2
Actual overhead                          8,500        8,500
Fixed overhead absorbed           8,800        7,600
(over)/under absorption              (300)         900
3.                                                year1         year2
Opening inventory                          -             200
Add: production                          4400          4000
Less:sales                                 (4200)       (3800)
Closing inventor                           200             -
Valued at full cost/unit$8           $1,600         $ 0
 
Using marginal costing:
                                                        Year 1             Year 2
                                                            $                    $
Sales                                               42,000            40,000
 
Variable production costs:
     Opening inventory                                             1,200
Production:                                     26,400            22,800
   
Closing inventory                           (1,200)                   
Variable selling & distribution         (4200)            (4,000)
Contribution                                  12,600             12,000
 
Fixed costs
   Production                                  (8,500)            (8,500)
   Selling & distribution                  (2,000)             (2,000)                    
Profit                                              2,100               1,500
 
Workings
1.                                                   year 1              year 2
Opening inventory                            -                     200
Add:production                              4,400               4,000
Less sales                                    (4,200)             (3,800)
Closing inventory                            200                       -
 
Valued at full cost/unit $6             $1,200                $0
 
AC profit                                                                         year 1                  year 2
Add: fixed overhead in opening inventory                      2,500                   1,100
Less: fixed overhead in closing inventory                           -                       400
MC profit                                                                        400                          -
200*$2                                                                          2,100                   1,500
 
        The difference in profits reported under the two costing systems is due to the different inventory valuation methods used. In the example, the difference $400 (2500-2100=400) is due to the difference in inventory.
        If inventory levels increase between the beginning and end of a period, absorption costing will report the higher profit bacause some of the fixed production overhead incurred during the period will be carried forward in closing inventory (which reduces cost of sales) to be set against sales revenue in the following period instead of being written off in full against profit in the period concerned.
        If inventory levels decrease, absorption costing will report the lower profit bacause as well as the fixed overhead incurred, fixed production overhead which had been carried forward in opening inventory is released and is also included in cost of sales.
        The difference between the figures will effectively be the OAR/unit * movement in inventory.
 
In all, we can conclude:
1.Production=sales  (so inventory is constant)
AC profit = MC profit
2.Production<sales  (so inventory is constant)
AC profit< MC profit
3.Production>sales  (so inventory is constant)

AC profit > MC profit

——高顿研究中心 Vincent Zhao

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