WEEK 6.

MARGINAL AND ABSORPTION COSTING TECHNIQUES

MARGINAL COSTING

Its also known as variable costing since it treats fixed costs as period costs and only uses variable costs
to determine the value of a product

Contribution per unit = Selling price per unit – Variable cost per unit

Under this technique the profit is determined using the following format

Kshs Kshs

Sales xxxxxx

Less cost of sales (Marginal production costs Only)

Opening inventory xxxxx

Add: Variable cost of production xxxxx

Less: Closing inventory (xxxxx) (xxxxx)

Gross contribution Xxxxx

Less: Other variable costs (xxxxx)

Net contribution xxxxxx

Less: Fixed costs (actually incurred) (xxxxx)

Profit/loss xxxxx

Example 1

XYZ ltd makes only one product whose cost card is as follows:

Cost card per unit

$
Direct materials: vc 3
Direct labour: vc 6
Variable production overheads: vc 2
Fixed production overheads 4
Variable selling cost 5
selling price 21
Budgeted fixed overheads are based on budgeted production of 5,000 units. Opening inventory was
1,000 units and closing inventory was 4,000 units

Sales during the period were 3,000 units and actual fixed production overheads were $ 25,000

Required: Prepare the income statement for the period using marginal costing technique.

W1: Total vc production cost per unit = 3+6+2= 11

W2: os+p-cs=sales
1,000+P-4,000= 3,000

p-3,000 = 3,000

Production = 3000+3000 = 6,000

Income statement

Using marginal costing technique

$ $

Sales: 3,000 x 21 63,000

Less cost of sales( Marginal/variable production cost)

Opening stock 1,000x 11 11,000

Add: Production 6,000X 11 66,000

Less: closing stock 4,000X11 (44,000) ( 33,000)

Gross contribution 3,000( 21- 11) 30,000

Less other variable costs

Variable selling costs: 5X 3,000 (15,000)

Net contribution 3,000( 21-11-5) 15,000

Less fixed costs incurred ( 25,000)

Profit/( loss) ( 10,000)

Absorption Costing

Its also known as full costing since it considers both the variable production costs and fixed costs in
determining the value of the inventory.
Under this technique the income statement is prepared using the following format.

Kshs Kshs

Sales xxxx

Less: cost of sales (Valued at full production cost)

Opening inventory xxxxx

Variable cost of production xxxxx

Fixed overheads absorbed xxxxx

Less: Closing inventory (xxxxx) (xxxxx)

Xxxxx

(Under)/ Over absorption of overheads xxxxx

Gross profit xxxxx

Less: Non production costs (xxxxx)

Profit/( Loss) xxxxx

Note: the differences between the profits in marginal costing and absorption costing technique is
because of the differences in the valuation of inventory.
Using example 1 above prepare the income statement using absorption costing technique

W1. Full production cost per unit = 15 = 3+6+2+4 =15

W2 overheads absorption

Absorbed overheads 6,000* 4 24,000

Actual production fixed overheads ( 25,000)

Under absorption (1,000)

Income statement

Using Absorption/Full costing technique

$ $

Sales 3,000* 21 63,000

Less cost of sales ( at Full production cost)

Opening stock 1,000*15 15,000

+Production 6,000*15 90,000

-Closing stock 4,000*15 (60,000) (45,000)

18,000

(under)/ Over-absorption of overheads (1,000)

Gross profit 17,000

Less other expenses

Variable selling costs: 5X 3,000 (15,000)

Net profit/ (loss) 2,000

Reconciliation of the profits

Absorption Marginal difference

Closing stock 60,0000 44,000

Opening stock 15,000 11,000

Difference 45,000 33,000 12,000

Profits 2,000 (10,000) 12,000

Hence the differences in profits is because of the difference in the valuation of inventory

Example 2

A company commenced business on 1st March 2020 making one product only. The cost card of the
product is as follows:

Cost card per unit

$
Direct materials 8
Direct labour 5
Variable production overheads 2
Fixed production overheads 5
Standard production cost 20
The fixed production overheads figure has been calculated on the basis of budgeted normal output of
36,000 units per annum. The fixed production overheads incurred in March was $ 15,000 each month.

Selling, distribution and administration expenses are:

Fixed $ 10,000 per month

Variable 15% of sales value
The selling price per unit is $ 35 and the number of units produced and sold were as follows:

March (Units)
Production 2,000
Sales 1,500

Required:

a) Prepare income statement using Marginal costing technique

Income statement

For the month of march 2020

Using Marginal/ variable costing technique

$ $

Sales 1,500*35 52,500

Less cost of sales ( Marginal/variable production costs)

Opening stock 0

+production 2,000*15 30,000

-Closing stock 500*15 ( 7,500) (22,500)

Gross contribution 30,000

Less other variable costs

Selling ,distribution $ admin 15%* 52,500 (7,875)

Net contribution 22,125

Less fixed costs incurred:

Production fixed overheads 15,000

Selling,distribution $ admin 10,000 (25,000)

Net profit/ (loss) ( 2,875)

b) Prepare income statement using absorption costing technique

W1 Under/ overabsorption of overheads

Oveheads absorbed 2,000*5 10,000

Actual overhedas 15,000

Under-absorbed overheads 5,000

Income statement

For the month of march 2020

Using Absorption/ Full costing technique

$ $

Sales 1,500*35 52,500

Less cost of sales ( at Full production cost)

Opening stock 0

+Production 2,000*20 40,000

-Closing stock 500*20 (10,000) (30,000)

22,500

(under)/ Over-absorption of overheads (5,000)

Gross profit 17,500

Less other expenses

Fixed 10,000

Variable 7,875 (17,875)

Net profit/ (loss) (375)

 c) Reconcile the Marginal and absorption costing techniques profits

Reconciliation of the profits

Absorption Marginal difference

Closing stock 10,0000 7,500

Opening stock 0 0

Difference 10,000 7,500 2,500

Profits (375) (2,875) 2,500

Hence the differences in profits is because of the difference in the valuation of inventory
Test understanding 1:
The standard cost per unit of product J manufactured by design manufacturing ltd is as shown
below:
Sh
Direct material 120
Direct labour 130
Variable overheads 150
Fixed overheads 200
Total production cost 500
Standard profit 150
Selling price 750
Additional information:
1.The actual data for the month of October 2020 was as follows:
Units
Opening stock 14,000
Closing stock 12,500
Sales ( Sh.700 per unit) 25,000
2.Actual fixed overheads incurred amounted to sh. 4,500,000
Required: Prepare the income statement using:
(i) Marginal costing (8 Marks)
(ii) Absorption costing (8 Marks)
(iii) Reconciliation statement for the profits obtained in I and ii above (4 Marks)#

Test Understanding 2
Meka Ltd manufactures a single product branded ‘’K’’. The standard cost per unit of the product
is given below;

Frw
Direct materials 700

Direct labour 350

Variable production overheads 400

Additional information:

1. Production and sales for the month of July and august 2013 are follows:

July 2013 August 2013

Units Units

Production 2,000 3,200

Sales 1,750 2,750

2. The selling price per unit of ‘’K’’ is Frw 2,010

3. The fixed production overheads are budgeted at Frw 14,400,000 per annum.

4. Budgeted administration and selling costs are estimated at Frw 6 million and Frw 3
million per annum.

5. The variable marketing costs are estimated at 10% of sales.

Required:

a) Profit statement for the month of august 2013 using:

i. Marginal costing ( 8 marks)

ii. Absorption costing (8 Marks)

b) Reconcile the profits obtained in (a) above (4 marks)