Marginal Vs Absorption Review Questions

PERFOMANCE MANAGEMENT (B5) COVENANT FINANCIAL CONSULTANTS LIMITED
Question one: ACCA adapted

Mawenzi company is considering its plans for the year ending 31 December 2017..It makes
and sells a single product, which has budgeted costs and selling costs as follows:
per unit $
Selling price 45
Direct materials 11
Direct Labour 8
Production overhead;
Variable 4
Fixed 3
Selling overhead;
Variable 5
Fixed 2
Administration overhead;
Fixed 3
Fixed overhead costs are based on normal annual activity level of 96,000 units. These
costs are expected to be incurred at a constant rate throughout the year.
Units January units February units

Sales 7,000 8,750
Production 8,500 7,750
Assume that there will be no stocks hold 1 Jan 2017.
Required:
(a) Prepare in columnar format, profit statements for each of the two months of
January and February 2015 using:
(1) Absorption costing
(2) Marginal costing
(b) Reconcile and explain the reasons for any differences between the marginal and absorption
profits for each month which you have calculated in (a) above.
(c) Based upon marginal costs, calculate:
(i) The annual break-even sales value
(ii) The activity level, in units, which will yield an annual profit of USD 122,800
(d) Explain three fundamental assumptions underpinning single product breakeven
analysis
Question Two: ACCA adapted

The following information relates to product J, for quarter 3, which has just ended:
Production Sales Fixed Variable

(units) (units) overheads costs
(000) (000)
Budget 40 000 38 000 300 1,800
Actual 46 000 42 000 318 2,070
Prepared By: Godson Mkaro (Jr): MSc Finance & Investment, BSc. Computer Science, ATEC II, CPBE, CPA (T),
& Goodhope Mkaro (Sr): MBA(Finance), BCOM Acc(Hons), PGD in Tax Management, CPB, CISI(UK), CPA (T)
Phone: +255 717 / 769 348 616 | Email: info@covenantfinco.com |Website: www.covenantfinco.com Page | 1
The selling price of product J was £72 per unit.

The fixed overheads were absorbed at a predetermined rate pet unit.
At the beginning of quartet 3 there was an opening stuck of product J of 2000 units, valued at £25
per unit variable costs and £5 per unit fixed overheads.
REQUIRED:
(a) (i) Calculate the fixed overhead absorption rate per unit for the last quarter, and present profit
statements using (First In, First Out using:
(ii) Absorption costing;
(iii) Marginal costing; and
(iv) Reconcile and explain the difference between the profits or losses. (12 marks)
(b) Using the same data, present similar statements to those requited in part (a). Using the AVECO
(average cost) method of valuation, reconcile the profit or loss figures, and comment briefly on
the variations between the profits or losses in (a) and (b). (8 marks) (Total 20 marks)
Question Three: ACCA adapted

The Miozip Company operates an absorption costing system which incorporates a factory-wide
overhead absorption rate per direct labour hour. For 2011 and 2012 this rate was £2.10 per hour.
The fixed factory overhead for 2012 was £600 000 and this would have been fully absorbed if the
company had operated at full capacity, which is estimated at 400 000 direct labour hours.
Unfortunately, only 200 000 hours were worked in that year so that the overhead was serious
under-absorbed. Fixed factory overheads are expected to be unchanged in 2013 and 2014.
The outcome for 2012 was a loss of £70 000 and the management believed that a major cause of
this loss was the low overhead an costing, absorption rate which had led the company to quote
selling prices which were uneconomic.
For 2013 the overhead absorption rate was increased of £3.60 per direct labour hour and selling
prices were raised in line with the monthly loss for established pricing procedures; which involve
adding a profit mark-up of 50 per cent onto the full factory cost of the company’s products. The
new selling prices were also charged on the stock of finished goods held at the beginning of 2013.
In December 2013 the company’s accountant prepares an estimated Profit and Loss Account for
2013 and a budgeted Profit and Loss Account for 2014. Although sales were considered to be
depressed in 2012, they were even lower in 2013 but, nevertheless, it seems that the company will
make a profit for that year. A worrying feature of the estimated accounts is the high level of
finished goods stock held and the 2014 budget provides for a reduction in the stock level at 31
December 2014 so the (physical) level existing in January 2012. Budgeted sales for 2014 are set
at the 2013 sales level.
The summarized profit statements for the three years to 31 December 2014 are as follows:
Summarized profit and

Actual 2012 loss accounts
estimated 2013 Budgeted 2014
(£) (£) (£) (£) (£) (£)
Sales revenue 1,350,000 1,316,25 1,316,250
0
Opening stock of 100 000 200 000 357 500
finished goods
Factory cost of 1 000000 975000 650,000
production 1100 000 1175 000 1.007,500
Less: Closing stock of 200000 357,500 130,000
finished goods
Factory cost of goods 900000 817 500 877 500
sold 450 000 498 750 438 750
Less: Factory overhead 300 000 150 000 300 000
under-absorbed 150 000 348 750 138 750
Admin &Financial 220 000 220 000 220 000
costs Loss (£70 000) £128 750 Loss (£81 250)
(a) You are required to write a short report to the board of Miozip explaining why the budgeted
outcome for 2014 is so different from that of 2013 when the sales revenue is the same for both
years. (6 marks)
(b) Restate the profit and loss account for 2012, the estimated profit and loss account for 2013
and the budgeted profit and loss account for 2014 using marginal factory cost for stock
valuation purposes. (8 marks)
(c) Comment on rise problems which may follow from a decision to increase the overhead
absorption rate in conditions when cost plus pricing is used and overhead is currently under-
absorbed. (3 marks)
(d) Explain why the majority of businesses use full costing systems whilst most management
accounting theorists favour marginal costing. (5 marks)
NB: Assume in your answers to this question that the value of the pound and the efficiency of the
company have been constant over the period under review. (Total 22 marks)
Question Four: NBAA ADAPTED

The Management of the Company intended to have two income statements, one based variable
costing and another based on absorption costing for decision purpose. In order to prepare these
statements, the following information was assembled and handled to you for the necessary action.
(i) Opening stock at the beginning of the operating period consisted of 25,000 finished units, and
5,000 units in process that were 100% complete with respect to raw materials, and 20%
complete with respect to conversion.
(ii) During the operating period ended the company introduced and transferred out 230,000 units
to the warehouse. In the same period, the company sold 210,000 units each at Tshs 4200. The
expenditure in the period, didn’t differ from the expectations expect for reasons of operating
volume change. The company targeted to produce and sale 240,000 units.
The expenditure in question included the following:
Tshs
Unit direct materials cost 500
Unit direct labour cost 600
Unit variable factory overhead cost 400
Annual fixed factory cost 98,000,000
Annual fixed administration cost 250,000,000
Annual fixed distribution cost 100,000,000
Required:
(a) Indicate the equivalent production units to which overhead was applied in the period ended.
(4 Marks)
(b) Prepare two Statement of Income, one based on variable costing and another based on
absorption costing ( 8 marks)
(c) Reconcile the income’s difference. (8 marks)
Question Five (NBAA Adapted)

The General Manager of Maravanda LTD has received the following income statement for the
month of May 2013, which was prepared on a direct costing basis.
Maravanda Company
Income statement for the month of May 2013 ( Shs)
Sales 60,000,000
Less: Variable Cost of goods sold 30,000,000
Contribution Margin 30,000,000
Less: Fixed Manufacturing costs at budget (15,000,000)
Gross Margin 15,000,000
Less: Fixed Selling and Administrative Expenses (10,000,000)
Net Income before taxes 5,000,000
The following notes were attached to the income statement:-

Shs
(i) The unit sales for May 2013 averaged 6,000
(ii) The unit manufacturing costs were:- Shs

Variable costs 3,000
Fixed costs applied 1,000
Total costs 4000
(iii) The unit fixed manufacturing overhead is based upon a normal monthly production of 15,000
units
(iv) Variable costs per unit have been stable throughout the year.
(v) Production for May 2013 was 4,500 units in excess of sales
(vi) The inventory at May 30th 2013 consisted of 8,000 units
Being the first time, the General Manager was presented with an Income statement prepared on a
direct costing basis; he was very comfortable with the results and kept on wondering what the net
income would have been under the absorption costing basis.
REQUIRED
(i) Present the May 2013 income statement on an absorption costing basis
(ii) Reconcile and explain the differences in net income between the two costing bases.
Question six (NBAA Adapted)

A newly employed Management Accountant scribbled the following financial statement and
presented it to the Management of Dudumiza Co:
DUDUMIZA CO. INCOME STATEMENT FOR THE YEAR ENDED MARCH 31,2012
Tshs Tshs
Sales 240,000,000
Less cost of sales (not 1)
Opening stick costs 18,000,000
Add production costs 124,000,000
Available for sale 142,000,000
Closing stock 22,000,0000
Cost of sale -120,000,000
Gross profit 120,000,000
Administration expenses 40,000,000
Marketing expenses (note 2) 42,000,000 -82,000,000
Operating income 38,000,000
Note 1: Prices for factory inputs have remained stable as was anticipated. Unit costs were as
follows:
Tshs
Unit variable costs: 220
Unit fixed overhead (at 300,000 units) 180
Total product cost 400
Note 2: A greater part of marketing cost was fixed with the exception of sales commission equal to 4% of sale v
and this is part of total marketing costs.
The report was to be used by Management in order to assess the operating outcome for the period
ended. All members of management team with the exception of the Finance Manager accepted the
financial statement. The Finance Manager was dismayed by an omission in the report, which
rendered it to be inaccurate. This was besides the fact that it was not based on variable costing.
In the course of planning production budget for the period ended, the company did not anticipated
changes in inventory levels.
REQUIRED:
(a) Point out the omission in the report and indicate its implication. (4marks)
(b) Prepare a similar income statement which is free from the error that the Finance Manager had
in mind. (7marks)
(c) Use a Cost – Volume - Profit model to establish the profit that the business targeted to earn
in the year ended. (3 marks)
(d) Reconcile the difference between the income statement you have just prepare in requirement
(b) above and the income that the business planned to earn. (Total 22 marks)
Question Seven (CIMA & NBAA Adapted)

The following budgeted profit statements has been prepared using absorption costing
principles
January to June July to December
($000) ($000) ($000) ($000)
Sales 540 360

Opening stock 100 160
Production cost;
Direct materials 108 36
Direct labour 162 54
Overhead 90 30
460 280
Closing stock 160 80
300 200
240 160
GROSS PROFIT
Production overhead:
(over)/under absorption (12) 12
Selling cost 50 50
Distribution cost 45 40
Administration cost 80 163 80 182
NET PROFIT/LOSS 77 (22)
Sales units 15,000 10,000

Production units 18,000 6,000
The members of the management team are concerned by the significant change in
profitability between the two six-month periods. .As a management accountant, you
have analyzed the data upon which the above budget statement has been produced, with
the following results;
1. The production overhead cost comprises both fixed and variable element,the
latter appears to be dependent on the number of units produced .The fixed
element of the cost is expected to be incurred at constant rate throughout the
year.
2. The selling cost are fixed
3. The distribution comprises both fixed and variable elements,the latter appears to
be dependent on the number of units sold.The fixed element of the cost is expected
to be incurred at a constant rate throughout the year.
4. The administration costs are fixed
REQUIRED:
(a) Present the above budgeted profit statement in marginal costing format
(b) Reconcile EACH of the six-monthly profit/loss values reported respectively under
marginal and absorption costing.
(c) Reconcile the six-monthly profit for January to June from the absorption costing
statement with the six-monthly loss for July to December from the absorption
costing statement.
(d) Calculate the annual number of units required to break even.
(e) Explain briefly the advantages of using marginal costing as the basis of providing
managers with information for decision making.
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PERFOMANCE MANAGEMENT (B5) COVENANT FINANCIAL CONSULTANTS LIMITED

Question one: ACCA adapted

Units January units February units

Assume that there will be no stocks hold 1 Jan 2017.

Question Two: ACCA adapted

Production Sales Fixed Variable

The selling price of product J was £72 per unit.

Question Three: ACCA adapted

Summarized profit and

Question Four: NBAA ADAPTED

The expenditure in question included the following:

Question Five (NBAA Adapted)

The following notes were attached to the income statement:-

(ii) The unit manufacturing costs were:- Shs

Question six (NBAA Adapted)

Operating income 38,000,000

Question Seven (CIMA & NBAA Adapted)

($000) ($000) ($000) ($000)

Sales 540 360

Sales units 15,000 10,000

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