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Absorption and Marginal Costing - Worked Examples

Management Accounting 1: a Business Decision Emphasis (University of Glasgow)

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Absorption vs Marginal Costing

Example 1
This example comes from Drury

£
Unit selling price 10
Unit variable cost 6
Fixed manufacturing cost per period 300,000
Non-manufacturing costs per period 100,000

The company makes one product. Budgeted activity is for 150,000 items to be
made each period. There were no opening inventories at the start of Period 1,
and all production is finished within each period.

Assume actual manufacturing fixed costs are £300,000 for each period.

Here is a schedule of production and sales for each period 1-6 inclusive.

Period 1 2 3 4 5 6
Sales (000) 150 120 180 150 140 160
Made (000) 150 150 150 150 170 140

Prepare marginal and absorption costing statements for each period 1-6
inclusive.

Marginal costing statements

Product cost = variable cost only, ie £6 each.

Period 1 2 3 4 5 6
£000 £000 £000 £000 £000 £000
Sales 1,500 1,200 1,800 1,500 1,400 1,600
Opening Inv’y Nil Nil 180 Nil Nil 180
Production Cost 900 900 900 900 1,020 840
Less closing inv’y Nil (180) Nil Nil (180) (60)
Marginal COS 900 720 1,080 900 840 960
CONTRIBUTION 600 480 720 600 560 640
Less
Fx’d pdct’n cost (300) (300) (300) (300) (300) (300)
Non manuf. FC (100) (100) (100) (100) (100) (100)
NET PROFIT 200 80 320 200 160 240

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Absorption costing statements

Product cost = variable cost plus (£300,000/150,000) ie £2 manufacturing fixed

overhead; so it works out at £8 each.

Period 1 2 3 4 5 6
£000 £000 £000 £000 £000 £000
Sales 1,500 1,200 1,800 1,500 1,400 1,600
Opening inv’y Nil Nil 240 Nil Nil 240
Productn Cost 1,200 1,200 1,200 1,200 1,360 1,120
Less clo. Inv’y Nil (240) Nil Nil (240) (80)
(Over)/under
Recovery MFC Nil Nil Nil Nil (40) 20
Cost of Sales 1,200 960 1,440 1,200 1,080 1,300
Gross profit 300 240 360 300 320 300
Non manuf. FC (100) (100) (100) (100) (100) (100)
Net profit 200 140 260 200 220 200

A business with seasonal sales

A firm makes high-quality deckchairs, which sell for £50 each. Production
proceeds evenly throughout the year, but most sales take place in summer
(period 4). Here is a schedule of the firm’s production and sale pattern.

Period 1 2 3 4
Production 500 500 500 500
Sales 100 100 300 1,500

Sales price is £50 each, and variable costs of manufacture are £25 each. Fixed
overheads are £20,000 per annum. There are no other costs of production.

Prepare absorption and marginal profit statements

(Note; cost of production in absorption costing is £25 + (£20,000/2,000) = £35

each. Cost of production in marginal costing is £25 each. Assume actual fixed
overhead is equal to budget, and that production proceeded according to the
schedule above.

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Marginal costing statement

Period 1 2 3 4
£ £ £ £
Sales 5,000 5,000 15,000 75,000
Opening inventory Nil 10,000 20,000 25,000
Marginal costs of prodct’n 12,500 12,500 12,500 12,500
Less closing inventory (10,000) (20,000) (25,000) NIL
Marginal cost of sales 2,500 2,500 7,500 37,500
Contribution 2,500 2,500 7,500 37,500
Fixed cost (5,000) (5,000) (5,000) (5,000)
Profit/(Loss) (2,500) (2,500) 2,500 32,500

Profits total £30,000 for the year.

Absorption costing statement

Period 1 2 3 4
£ £ £ £
Sales 5,000 5,000 15,000 75,000
Opening inventory Nil 14,000 28,000 25,000
Cost of production 17,500 17,500 17,500 17,500
Less closing inventory 14,000 28,000 35,000 Nil
Cost of sales 3,500 3,500 10,500 52,500
Profit 1,500 1,500 4,500 22,500

Again, profits total £30,000 for the year.

Example 2
This example is adapted from Drury (similar to IM7.3)
The following information relates to periods 1-4 inclusive

£
Variable cost per unit 30
Selling price per unit 55
Fixed costs per period 6,000

Normal activity is 500 units per quarter and production and sales data for the first
four quarters are as follows. There was no opening inventory in period 1.

Period 1 2 3 4
Sales 500 400 500 450
Production 500 500 450 550

Required

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Prepare marginal and absorption costing statements for each of periods 1-

4 inclusive.

SOLUTION
For absorption costing, we absorb MFO into products at the rate of £6,000/500 =
£12 per item, giving total product cost £30 + £12 = £42. There is no under or
over absorption in Periods 1 and 2, but in Period 3, not enough fixed overheads
have been charged to production. So we have to charge an under-absorption of
£12 x 50 = £600. Likewise in Period 4, we have an over-absorption of 12 x 50 =
£600.

Period 3 opening inventory is 100 units. We made another 450 units, and sold
500 units, giving closing inventory of 50 units. Period 4 opening inventory is 50
units. We made 550 units, but only sold 450 units, so Period 4 closing inventory
is 150 units
ABSORPTION COSTING
Period 1 2 3 4
Sales 27,500 22,000 27,500 24,750
Opening Inventory Nil Nil 4,200 2,100
Cost of production 21,000 21,000 18,900 23,100
21,000 21,000 23,100 25,200
Closing inventory Nil 4,200 2,100 6,300
(Over)/under absorption Nil Nil 600 (600)
Cost of goods sold 21,000 16,800 21,600 18,300
Net profit 6,500 5,200 5,900 6,450

MARGINAL COSTING
Period 1 2 3 4
Sales 27,500 22,000 27,500 24,750
Opening Inventory Nil Nil 3,000 1,500
Cost of production 15,000 15,000 13,500 16,500
15,000 15,000 16,500 18,000
Closing inventory Nil 3,000 1,500 4,500
Marginal Cost of goods sold 15,000 12,000 15,000 13,500
Contribution 12,500 10,000 12,500 11,250
Fixed manufacturing 6,000 6,000 6,000 6,000
overheads
Net profit 6,500 4,000 6,500 5,250

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