Absorption and marginal

costing
Zaira Anees
Absorption costing Marginal costing
Fixed production overheads are treated as PRODUCT Fixed production overheads are treated as PERIOD cost
cost

Stocks are valued on the basis of full production cost Stocks are valued on the basis of variable production
(manufacturing cost per unit) cost

Manufacturing cost is the sum of Prime cost, variable Variable manufacturing cost is the sum of Prime cost
production overheads and fixed production overheads and variable production overheads only

Gross profit is the difference between sales and COGS Contribution is the difference between sales and ALL
(selling price and manufacturing costs) variable costs of sales (manufacturing and non
manufacturing both)

Difference between manufacturing and non Difference between fixed and variable cost is important
manufacturing cost is important

Used in stock valuation Mostly used in decision making

Product cost vs Period cost
Format of Absorption costing
• Sales revenue (selling price * sales volume) xx
• Cost of goods sold
• Opening stock xx
• Production cost xx
• Closing stock xx xx
• Unadjusted gross profit xx
• Under (-) or over (+) recovery of overheads xx
• Adjusted gross profit xx
• Less: non manufacturing overheads xx
• Profit under absorption costing xx
Format of Marginal costing
• Sales revenue (selling price * sales volume) xx
• Variable cost of sales
• Opening stock xx
• Variable production cost xx
• Closing stock xx
• xx
• Add: Variable non manufacturing overheads xx xx
• Contribution xx
• Less: All fixed costs xx
• Profit under marginal costing xx
Computations of unit production cost
• Inventory valuation under absorption costing will always be higher
than inventory under marginal costing, because there are more costs
in each unit under absorption costing,
• The number of units in ending inventory are the same under both
methods.
Income statement (comparison)
• Big Woof Co manufactures a single product, the Bark, details of which are as
follows.
• Per unit $
• Selling price 180.00
• Direct materials 40.00
• Direct labour 16.00
• Variable overheads 10.00
• Annual fixed production overheads are budgeted to be $1.6 million and Big
Woof expects to produce 1,280,000 units of the Bark each year. Overheads are
absorbed on a per unit basis. Actual overheads are $1.6 million for the year.
• Budgeted fixed selling costs are $320,000 per quarter.
• Production was 280,000 units out of which company sold 240,000 units during
the first quarter
• There is no opening inventory at the beginning of January.
• Prepare statements of profit or loss for the quarter, using:
• (a) Marginal costing (b) Absorption costing
Effects of Changing Inventory Levels
• When production and sales are equal in a period (no change in inventory levels)
there will be no difference between the profit reported under these two
methods.
• If production is greater than sales*, (closing stock > opening stock) then the
profit calculated under the absorption method is greater because some of the
fixed factory overheads were transferred to next period through closing stock.
• If production is less than sales †, (closing stock < opening stock) then the profit
calculated under the absorption method is less than marginal costing because
less fixed factory overheads were transferred to next period through closing
stock.
• *Operating income is higher under absorption costing, since fixed manufacturing overhead
cost is deferred in inventory under absorption costing as inventories increase.
• †Operating income is lower under absorption costing, since fixed manufacturing overhead
cost is released from inventory under absorption costing as inventories decrease.
Reconciliation statement b/w absorption and
marginal costing
• Profit under absorption costing xx
• Change in closing stock xx
(units * fixed production OAR)
• Profit under Marginal costing XX

• Increase in closing stock → deduct

• Decrease in closing stock → add
• http://kfknowledgebank.kaplan.co.uk/KFKB/Wiki%20Pages/Marginal
%20and%20absorption%20costing.aspx
 Shortcuts for MCQs (Absorption costing)
• Stock valuation under absorption costing is on the basis of manufacturing cost
per unit (prime cost +variable production overheads + fixed production
overheads)

• Production cost = quantity produced * manufacturing cost per unit

• Closing stock valuation = closing stock * manufacturing cost per unit

• Unadjusted gross profit = (selling price – manufacturing cost per unit) * sales
volume
 Shortcuts for MCQs (Marginal costing)
• Stock valuation under marginal costing is on the basis of variable
manufacturing cost per unit (prime cost +variable production overheads)

• Production cost = quantity produced * variable manufacturing cost per unit

• Closing stock valuation = closing stock * variable manufacturing cost per unit

• Unadjusted gross profit = (selling price – all variable costs per unit) * sales
volume
Q1.
• 3 kg of plastic is expected to consume in manufacturing of one unit of
chair. Labour is expected to consume 5 hours. Price of plastic is £10
per kg and wage rate of labour is £6 per hour. Variable production
overheads are expected to be £3.2 per labour hour and Fixed
overhead absorption rate is £4.7 per hour.
• If company is using absorption costing, at what cost it should value
one unit of Chair
• ___________
Q2.
• 3 kg of plastic is expected to consume in manufacturing of one unit of
chair. Labour is expected to consume 5 hours. Price of plastic is £10
per kg and wage rate of labour is £6 per hour. Variable production
overheads are expected to be £3.2 per labour hour and Fixed
overhead absorption rate is £4.7 per hour.
• If company is using marginal costing, at what cost it should value one
unit of Chair
• ____________
Q3.
• Following are details given about a product
• Direct Materials 6.00
• Direct labour 7.50
• Variable overhead 2.50
• Fixed overhead absorption rate 5.00
• Variable selling overheads 1.2
• Selling price 30.00
• The company managed to produce 5,800 units, selling 5,200 of them and
incurring fixed overhead costs of $27,400.
• What was the closing stock valuation under absorption costing?
• _____12600_____
Q4.
• Following are details given about a product
• Prime cost 10.25
• Variable overhead 2.10
• Fixed overhead absorption rate 4.00
• Variable selling overheads 1.2
• Selling price 30.00
• The company managed to produce 6,000 units, selling 5,500 of them
• What was the production cost under absorption costing?
• ____98,100______
Q5
• Following are details given about a product
• Prime cost 10.25
• Variable overhead 2.10
• Fixed overhead absorption rate 4.00
• Variable selling overheads 1.2
• Selling price 30.00
• The company managed to produce 9,000 units, selling 8,000 of them
• What was the production cost under marginal costing?
• __________
Q6
• Following are details given about a product
• $
• Prime cost 6.00
• Variable overhead 8.50
• Fixed overhead absorption rate 5.00
• Variable selling overheads 12.00
• Selling price 50.00
• The company managed to produce 6,000 units, selling 5,200 of them
What was the total contribution margin? ____________
Q7
• A company recorded the following costs in October for Product X:
• $
• Direct materials 20,000
• Direct labour 16,300
• Variable production overhead 14,700
• Fixed production overhead 19,750
• Variable selling costs 4,500
• Fixed distribution costs 16,800
• During October 5,000 units of Product X were produced but only 3,600 units were sold. At the beginning of
October there was no inventory.
• The value of the inventory of Product X at the end of October using marginal costing was:
• A $10,164 B $14,280 C $15,540 D $19,810
• The value of the inventory of Product X at the end of October using absorption costing was:
___________.
Q8
• A company produces procuct X whosr selling price is £50 per unit. Unit cost data is as
follows:
• Direct material £15
• Direct labour £10
• Overheads cost
• Manufacturing Distribution
• Fixed £5 £4
• Variable £7 £3
• Answer the following
• What will be the unit product cost under absorption costing £_______.
• What will be the unit product cost under marginal costing £______
• What will be gross profit per unit £______________.
• What will be contribution per unit £_______________
Q9

• A company produces procuct X whosr selling price is £50 per unit. Unit cost
data is as follows:
• Direct material £15
• Direct labour £10
• Overheads cost
• Manufacturing Distribution
• Fixed £5 £4
• Variable £7 £3
• Answer the following
• What will be conversion cost per unit £_____________
• What will be variable conversion cost per unit £__________
Q10
• A company uses an absorption costing system. 10,000 units of product
were manufactured in a period during which 9,760 units were sold.
• If marginal costing is applied instead what would be the effect on profit?
• A Higher by (240 units x fixed production overhead cost per unit)
• B Lower by (240 units x fixed production overhead cost per unit)
• C Higher by [240 units x (fixed production overhead cost per unit + fixed
non-production overhead cost per unit)]
• D Lower by [240 units x (fixed production overhead cost per unit + fixed
non-production overhead cost per unit)]
Q11
• A company produced more than it sold. (Select TWO CORRECT
statements)
• A. Profit under absorption costing will be higher than marginal
costing.
• B. Profit under absorption costing will be lower than marginal costing.
• C. inventory valuation under absorption costing will be higher than
marginal costing.
• D. inventory valuation under absorption costing will be lower than
marginal costing.
Q12
• A company manufactures and sells a single product. For this month
the budgeted fixed production overheads are £48,000, budgeted
production is 12,000 units and budgeted sales are 11,720 units. The
company currently uses absorption costing.
• If the company used marginal costing principles instead of
absorption costing for this month, what would be the effect on the
budgeted profit?
• A £1,120 higher B £1,120 lower
• C £3,920 higher D £3,920 lower
Q13
Q14
• Opening stock 2,500 units
• Production volume 8,000 units
• Sales volume 9,000 units
• Total production cost $31
• Variable production cost $25
• Total variable cost $28
• Total cost $34
• Calculate change in value of inventory over the period under absorption costing
• Calculate change in value of inventory over the period under absorption costing
• Calculate change in profit under absorption and marginal costing
Q15
• Total budgeted contribution of coming month is expected to be
£300,000 from production and sale of 15,000 units. Fixed overheads
absorption rate is £10 per unit. There were no variable selling
overheads.
• If company uses absorption costing, then gross profit per unit will be
£__________
Q16
• Total budgeted contribution of coming month is expected to be
£300,000 from production and sale of 15,000 units. Fixed overheads
absorption rate is £10 per unit. Variable selling overheads are
expected to be £2 per unit. Selling price is £60 per unit
• If company uses absorption costing, then stock will be valued at
£__________
Q17
• A company had opening inventory of 48,500 units and closing
inventory of 45,500 units. Profits based on marginal costing were
$315,250 and on absorption costing were $288,250. What is the fixed
overhead absorption rate per unit?
Q18
• A company has calculated profit of £32,000 under absorption costing.
If it switches to marginal costing profit will increase by £8,000. Fixed
overheads absorption rate is £4 per unit. Opening stock of the current
year was 4,500 units. Calculate closing stock
Q19
Q20
• A company made 17,500 units at a total cost of £16 each. Three
quarter costs were variable and one quarter is fixed. Sales were
15,000 units at £14 each. There were no opening stock. By how much
will the profit will differ using absorption costing compared with
marginal costing
• £_____________ (higher / lower)
Q21
• A company makes single product with following costs (per unit)
• Selling price £60.00
• Direct material £12.50
• Direct labour £8.50
• Variable overheads £8.00
• Budgeted fixed production overheads costs are £360,000 per annum charged evenly across each
month of the year. Budgeted production is 18,000 units per annum. In July, actual production was
1400 units and exceeds sales by 100 units. Profit under marginal costing was 10,300.
• What will be profit reported under absorption costing?
• £12,300
• £11,300
• £10,000
• £20,000