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- 15 Marks
Question
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)
Answer
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)
- Topic: Standard Costing and Variance Analysis
- Series: MAY 2017
- Uploader: Dotse