Question Tag: Absorption Costing

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  • 12 Marks

MI – May 2016 – L1 – SB – Q1b – Costing Methods

Calculate production cost per unit, variable cost, contribution, break-even point, and total non-production cost.

Grammar Limited manufactures product G of which the sales for the year 2015 was ₦25,000,000 at the unit price of ₦40. Production overhead and selling overhead were ₦2.50 and ₦1.50 per unit, respectively. The following additional information are available for the year 2015:

₦/unit
Direct material used 8.50
Direct labour 7.50
Fixed production overhead 6.00
Fixed selling overhead 2.00
Administration overhead 4.00

You are required to calculate:

i. Full production cost per unit and value
ii. Variable cost per unit and value
iii. Contribution per unit and value
iv. Break-even point in value
v. Total non-production cost per unit and value
vi. New break-even point (to the nearest Naira) if additional distribution expenses of ₦1.50/unit was incurred

i. Full production cost per unit and value:

Production in units = 25 000 000 / 4 = 625,000 units

ii. Variable cost per unit and value:

 

Value 625,000 x N20.00 = 12,000,000

iii. Contribution per unit and value

Value 625,000 x N20.00 = 125,000,000

iv. Break even point in value

= N15,000,000

v. Total non-production cost per unit and value

Value 625,000 x N8.50 = N5,312,000

vi. New break-even cost point

=

=

= = N18,243,243

 

 

 

  • 8 Marks

MI – May 2016 – L1 – SB – Q1a – Costing Methods

State two advantages and two disadvantages of absorption and marginal costing.

State any TWO advantages and any TWO disadvantages of absorption and marginal costing.
(8 Marks)

Advantages of Absorption Costing:

  1. Provides a more accurate cost per unit as all costs, including fixed costs, are absorbed.
  2. Ensures compliance with accounting standards for financial reporting.

Disadvantages of Absorption Costing:

  1. Can be misleading for decision-making, as it allocates fixed costs to unit costs.
  2. May encourage overproduction to absorb fixed costs.

Advantages of Marginal Costing:

  1. Useful for decision-making as it focuses on variable costs and contribution margin.
  2. Simplifies cost control by excluding fixed overheads in unit cost calculations.

Disadvantages of Marginal Costing:

  1. Does not conform with external financial reporting standards.
  2. Ignores the importance of fixed costs in total cost structure.
  • 1 Marks

MI – May 2016 – L1 – SA – Q6 – Costing Techniques

Calculate the net profit using marginal costing based on given absorption costing profit and inventory data.

The net profit was N2,650,000 using absorption costing and the closing inventory was 14,600 units. Production overhead absorption rate was N18.50 per unit. If the Non-production absorption rate was N14.00 per unit, then the net profit using marginal costing is:
A. N2,379,900
B. N2,445,600
C. N2,650,000
D. N2,854,400
E. N2,920,100

Answer:
A. N2,379,900

Explanation:
To convert the profit from absorption costing to marginal costing, we need to adjust for the fixed production overheads included in the closing inventory. The formula is:

Change in Profit = Change in Inventory × Fixed Production Overhead per unit

The change in profit due to inventory is calculated as:


=N270,100 = N270,100

Since we are moving from absorption to marginal costing, we subtract this amount from the absorption costing profit:

N2,650,000 − N270,100 = N2,379,900

Thus, the profit using marginal costing is N2,379,900.

  • 15 Marks

MA – Nov 2019 – L2 – Q3b – Standard costing and variance analysis

Calculate and analyze sales-related variances for Sasraku Ltd’s three products based on given data for the last period.

b) Sasraku Ltd manufactures and sells standard quality fuel pumps. Other companies integrate these pumps in their production of petrol engines. At present, Sasraku Ltd manufactures only three different types of fuel pumps: oil pump, gas pump, and diesel pump. Simon, the Management Accountant, allocates fixed overheads to these pumps on an absorption costing system.

The standard selling price, volumes, and cost data for these three products for the last period are as follows:

The total fixed production overhead for the last period was estimated in the budget to be GH¢526,500. This was absorbed on a machine-hour basis.

The Board of Directors has decided to calculate the variances for the period to analyze the sales performance of the company.

The following information of actual volumes and selling prices for the three products in the last period was obtained:

Required:

i) Calculate the standard profit per unit.
(3 marks)

ii) Calculate the following variances for overall sales for the last period:
Sales profit margin variance
Sales mix profit variance
Sales quantity profit variance
Sales volume profit variance
(8 marks)

iii) Prepare a statement showing the reconciliation of budgeted profit for the period to actual sales less standard cost
(4 marks)

i) Calculation of standard profit per unit

Working
W1 calculation of overhead absorption rate Budget machine hours = (10,000*1.95) + (13,000*3.90) + (9,000*5.20) =117,000 hours As company follows absorption costing method, fixed overheads are allocated don
machine hours’ basis. Overhead adsorption rate = GH¢526,500/117,000 hours = GH¢4.50 per machine hour.
(3 marks evenly spread using ticks)

ii)

  • Actual sales quantity at actual profit margin (at actual selling price less
    standard cost)

  • Actual sales quantity at actual mix at standard profit

  • Actual sales quantity at standard mix at standard profit


Alternative approach to actual sales quantity in standard mix t standard profit
= Actual quantity * average standard profit per unit
=31,500 units* GH¢25.1875 per units = GH¢793,403

Sales profit margin variance

(2 marks)

Sales mix profit variance

Alternative solution
Sales profit margin variance

iii)Reconciliation statement

(4 marks evenly spread using ticks)

  • 15 Marks

MA – May 2017 – L2 – Q3a – Standard costing and variance analysis

Calculate the budgeted fixed production overhead costs and prepare profit statements using marginal and absorption costing.

Bosco Ltd makes and sells one product. Currently, it uses absorption costing to measure profits and inventory values. The budgeted production cost per unit is as follows:

Item Cost (GH¢)
Direct labour (3 hours at GH¢6 per hour) 18
Direct materials (4 kilograms at GH¢7 per kilo) 28
Production Overhead (Fixed cost) 20
Total Cost per Unit 66

Normal output volume is 16,000 units per year, and this volume is used to establish the fixed overhead absorption rate for each year. Costs relating to sales, distribution, and administration are:

  • Variable: 20% of sales value
  • Fixed: GH¢180,000 per year

There were no units of finished goods inventory on 1st October 2015. The fixed overhead expenditure is spread evenly throughout the year. The selling price per unit is GH¢140. For the two six-monthly periods detailed below, the number of units to be produced and sold are budgeted as follows:

Period Production (units) Sales (units)
Six months ending 31st March 2016 8,500 7,000
Six months ending 30th September 2016 7,000 8,000

The entity is considering whether to abandon absorption costing and use marginal costing instead for profit reporting and inventory valuation.

Required:

i) Calculate the budgeted fixed production overhead costs for each of the six-monthly periods. (3 marks)

ii) Prepare profit statements for management using:

  • Marginal costing
  • Absorption costing

(9 marks)

iii) Prepare an explanatory statement reconciling the profits under marginal costing with those of absorption costing.

(3 marks)

i) Budgeted Fixed Production Overhead Costs:

The budgeted fixed production overhead expenditure is calculated based on the normal output volume.

  • Normal production volume: 16,000 units per year
  • Fixed production overhead rate per unit: GH¢20
  • Total annual overhead cost: 16,000 units × GH¢20 = GH¢320,000
  • Fixed overhead per six-month period: GH¢320,000 / 2 = GH¢160,000

(3 marks)

ii) Profit Statements Using Marginal and Absorption Costing:

Marginal Costing Profit Statement:

Description Six months ending 31 March 2016 (GH¢) Six months ending 30 September 2016 (GH¢)
Sales (7,000 units @ GH¢140) 980,000 1,120,000
Less: Marginal Cost of Sales (7,000 units @ GH¢74) 518,000 592,000
Contribution 462,000 528,000
Less: Fixed Production Overheads 160,000 160,000
Less: Other Fixed Costs (Sales, Distribution, Admin) 90,000 90,000
Profit 212,000 278,000

Absorption Costing Profit Statement:

Description Six months ending 31 March 2016 (GH¢) Six months ending 30 September 2016 (GH¢)
Sales (7,000 units @ GH¢140) 980,000 1,120,000
Less: Cost of Sales (using absorption)
– Direct Costs (7,000 units @ GH¢66) 462,000 528,000
– Fixed Overhead Absorbed (Production) 170,000 (8,500 units @ GH¢20) 140,000 (7,000 units @ GH¢20)
Less: Under/(Over) Absorbed Overheads 10,000 (over-absorbed) (20,000) (under-absorbed)
Cost of Sales 518,000 572,000
Gross Profit 462,000 548,000
Less: Fixed Costs (Sales, Distribution, Admin) 286,000 314,000
Profit 242,000 258,000

(9 marks)

iii) Reconciliation of Profits Under Marginal and Absorption Costing:

The differences in reported profits between marginal costing and absorption costing arise from the treatment of fixed production overheads and changes in inventory levels.

Period Difference
Six months ending 31 March 2016 Increase in inventory (1,500 units × GH¢20) = GH¢30,000
Six months ending 30 September 2016 Decrease in inventory (1,000 units × GH¢20) = (GH¢20,000)

Reconciliation:

  • 31 March 2016: Absorption costing profit higher by GH¢30,000
  • 30 September 2016: Absorption costing profit lower by GH¢20,000

(3 marks)

  • 20 Marks

IMAC – NOV 2023 – L1 – Q1 – Marginal Costing and Absorption Costing

Prepare profit statements for January and February 2023 using marginal costing and absorption costing methods.

Alokome Plc is a company that produces and sells one product “Iga”. Information relating to the operations of Alokome Plc for the first two months of 2023 is as follows:

i) Iga sells for GH₵500 per unit.
ii) There were no inventories of Iga at the end of December 2022.
iii) Other relevant information is as follows:

Cost Element GH₵
Direct material and wages 220
Variable production overhead 30

Budgeted and actual costs per month:

Cost Element GH₵
Fixed production overhead 990,000
Fixed selling and administrative expenses 400,000
Variable selling expenses 12.5% of sales

Normal capacity: 110,000 units per month

Number of units produced and sold:

Month Sales (units) Production (units)
January 128,000 140,000
February 110,000 102,000

Required:
Using the information above, prepare in a columnar form profit statements for January and February 2023 using:
a) Marginal costing (10 marks)
b) Absorption costing (10 marks)

a) Alokome Plc – Profit Statement for January and February 2023 (Marginal Costing)

January (GH₵’000) February (GH₵’000)
Sales revenue 64,000 55,000
Less: Variable cost of sales:
Beginning inventory – 3,000
Production cost 35,000 25,500
Ending inventory (3,000) (1,000)
Variable cost of production 32,000 27,500
Variable selling expenses 8,000 6,875
Variable cost of sales (40,000) (34,375)
Contribution 24,000 20,625
Less: Fixed costs
Fixed production overhead (990) (990)
Fixed selling and admin. expenses (400) (400)
Profit 22,610 19,235
(Marks are evenly spread using ticks = 10 marks)

b) Alokome Plc – Profit Statement for January and February 2023 (Absorption Costing)

January (GH₵’000) February (GH₵’000)
Sales revenue 64,000 55,000
Less: Full cost of sales:
Beginning inventory – 3,108
Production cost 36,260 26,418
Ending inventory (3,108) (1,036)
Full cost of production 33,152 28,490
Gross profit (Notional) 30,848 26,510
Adjustment for under/over absorption of fixed prodn o/head 270 (72)
Gross profit (Actual) 31,118 26,438
Less: Selling and administrative expenses:
Variable selling expenses (8,000) (6,875)
Fixed selling and admin. expenses (400) (400)
Profit 22,718 19,163
(Marks are evenly spread using ticks = 10 marks)

Workings:

Calculation GH₵
Variable production cost per unit
Direct material and wages 220
Variable production overhead 30
Total 250
Calculation GH₵
Fixed production overhead per unit 9
Full production cost per unit
Direct material and wages 220
Variable production overhead 30
Fixed production overhead per unit 9
Total 259
  • 20 Marks

IMAC – MAR 2023 – L1 – Q3 – Marginal Costing and Absorption Costing | Scope of Management Accounting

Explain qualities of management accounting information, and differences between marginal and absorption costing.

a) Management accounting systems obtain information from both internal and external sources. Cost accounting system is one major source of management accounting information, and such information is only useful to managers if it possesses certain qualities.

Required:
In reference to the statement above, explain FIVE (5) qualities of management accounting information.
(10 marks)

b) Explain the following briefly:
i) Cost center (2.5 marks)
ii) Profit center (2.5 marks)

c) Explain TWO (2) differences between a marginal costing system and an absorption costing system.
(5 marks)

a)
Qualities of cost and management information:

  1. Relevance: Information should be timely and bear on the decision-making process by possessing predictive or confirmatory (feedback) value.
  2. Faithful representation: Information must be honestly presented, complete, neutral, and free from material error and misstatement.
  3. Comparability: Even though different companies may use different accounting methods, there is still sufficient basis for valid comparison.
  4. Consistency: Deviations in measured outcomes from period to period should be the result of deviations in underlying performance (not accounting quirks).
  5. Verifiability: Different knowledgeable and independent observers reach similar conclusions.
  6. Timeliness: Cost and revenue information not readily available to the organization at the right time for decision making is of no use. Information must flow to the decision maker at the right time and at the right place so that it can be of use to the decision maker.
    (Any 5 points @ 2 marks each = 10 marks)

b)
i) Cost center: This is a segment of the organization that has the authority to incur and control cost. Expense center is a responsibility center incurring only expense items and producing no direct revenue from the sale of goods or services. An example of expense centers are service centers, thus the maintenance department and accounting department of an organization. (2.5 marks)

ii) Profit center: Profit center is a responsibility center having both revenues and expenses objectives because segmental earnings equal segmental revenues minus related expenses; therefore, the manager must be able to control both of these categories of revenue and cost. (2.5 marks)

c)
The following are the major differences between marginal costing and absorption costing:

  1. Cost Inclusion: Marginal Costing apportions only variable costs to the products, while Absorption Costing absorbs both fixed and variable costs into the product cost.
  2. Profit Calculation: Marginal costing profit is calculated using the Contribution Margin (Sales – Variable Costs), whereas Absorption Costing calculates profit after deducting both fixed and variable costs from sales.
  3. Overhead Treatment: Marginal Costing treats fixed overheads as period costs, charged against revenue in the period incurred, while Absorption Costing includes fixed overheads in the product cost.
  4. Stock Valuation: Under Marginal Costing, stock is valued at variable cost, whereas under Absorption Costing, stock is valued at full cost (including fixed overheads).
  5. Presentation of Profit: Marginal Costing profit varies directly with sales volume, while Absorption Costing profit can vary with changes in stock levels due to fixed overheads absorption.
    (Any 2 points @ 2.5 marks each = 5 marks)
    (Total: 20 marks)
  • 20 Marks

IMAC – MAY 2021 – L1 – Q1 – Marginal Costing and Absorption Costing

Prepare profit and loss statements for QQQ Ltd using marginal and absorption costing techniques.

The following data has been extracted from the operating records of QQQ Ltd for the last two quarters of the year to 31 December 2020:

Quarter 3 4
Production units 7,000 8,500
Sales units 5,500 9,500
Description Amount (GH¢)
Selling price per unit 100
Direct material cost per unit 20
Direct labour cost per unit 15
Variable overheads per unit 10
  • Fixed production overheads are budgeted at GH¢120,000 for a budgeted production of 8,000 units per quarter. These overheads are absorbed on a per unit of production basis.
  • Non-production overheads comprised:
    • Fixed administration expenses GH¢40,000 per quarter
    • Selling and distribution expenses 10% of sales

Required:
a) Prepare a statement of profit or loss for each quarter using the Marginal Costing technique. (10 marks)

b) Prepare a statement of profit or loss for each quarter using the Absorption Costing technique. (10 marks)

a) Marginal Costing Statement of Profit or Loss for the two Quarters to 31st December 2020

Quarter 3 4
GH¢ GH¢
Sales (W1) 550,000 950,000
Variable cost of goods sold:
Opening Inventory – (67,500)
Production (W2) 315,000 382,500
Closing Inventory (67,500) (22,500)
Total Variable Production Cost 247,500 427,500
Non-Production Cost:
Selling & Dist. Cost 55,000 95,000
Total Variable Cost (302,500) (522,500)
Contribution 247,500 427,500
Fixed Costs:
Production 120,000 120,000
Non-production 40,000 40,000
Total Fixed Costs (160,000) (160,000)
Net profit 87,500 267,500

b) Absorption Costing Statement of Profit or Loss for the two Quarters to 31st December 2020

Quarter 3 4
GH¢ GH¢
Sales 550,000 950,000
Cost of Sales:
Opening Inventory – (90,000)
Production 420,000 510,000
Closing Inventory (90,000) (30,000)
Total Cost of Sales 330,000 570,000
Gross Profit 220,000 380,000
Expense:
Selling & Dist. 55,000 95,000
Admin. Expenses 40,000 40,000
Total Expenses (95,000) (135,000)
Over / (Under) Absorption (15,000) 7,500
Net Profit 110,000 252,500

Workings:

  • Computation of Product Cost/unit
    • Marginal Costing
      • Direct Material Costs: GH¢20
      • Direct Labour: GH¢15
      • Variable Overheads: GH¢10
      • Total Product cost/unit: GH¢45
    • Absorption Costing
      • Direct Material Costs: GH¢20
      • Direct Labour: GH¢15
      • Variable Overheads: GH¢10
      • Fixed Overheads: GH¢15
      • Total Product cost/unit: GH¢60
  • 20 Marks

IMAC – MAY 2020 – L1 – Q1 – Marginal Costing and Absorption Costing

Prepare profit or loss statements using marginal and absorption costing for Smooth Sailing Ltd.

Additional information:
Fixed production overheads are budgeted to be GH¢40,000 per month for a budgeted monthly
production of 20,000 units. Production overheads are absorbed on a unit of production basis.
Required:
a) Using marginal costing principles, prepare a statement of profit or loss for the THREE (3)
months to September 2019. (10 marks)
b) Using absorption costing principles, prepare a statement of profit or loss for the THREE (3)
months to September 2019. (10 marks)

 

Workings (W):
W1. Computation of product cost per unit

Marginal Costing Absorption Costing
Direct material GH¢14 GH¢14
Direct labour GH¢4 GH¢4
Variable overheads GH¢2 GH¢2
Fixed overheads (W2) – GH¢2
Total cost per unit GH¢20 GH¢22

W3. Over/ (Under) Absorption

Month July August September
GH¢’000 GH¢’000 GH¢’000
Overheads absorbed 30,000 32,000 24,000
Overheads incurred 40,000 40,000 40,000
Over/(under) absorption (10,000) (8,000) (16,000)
(All marks evenly spread for 10 marks using ticks)

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