TUTORIAL QUESTION

Absorption Costing & Marginal Costing

Using the following question, prepare a profit statement using absorption costing
principles and marginal costing for the months of May and June:

QUESTION 1:
Galway Plc manufactures and sells a single product .The following budgeted/ actual
information is provided in relation to the production of this product:
TZS
Selling price per unit 50.00
Direct materials per unit 8.00
Direct labour per unit 5.00
Variable production overheads per unit 3.00

Details for the months of May and June 2010 are as follows:
May June
Production of Product A 500 380
Sales of Product A (units) 300 500

Fixed production overheads are budgeted at TZS4,000 per month and are absorbed on a
unit basis. The normal level of production is budgeted at 400 units per month.

Other costs
Fixed selling TZS4,000 per month
Fixed Administration TZS2,000 per month
Variable sales commission 5% of sales revenue

There was no opening inventory of Product A at the start of May.

QUESTION 2
Chairs Limited commenced business on 1 January 20-7. It manufactures a special type of chair
designed to alleviate back pain. Information on the first year’s trading is as follows:
number of chairs manufactured 5,000
number of chairs sold 4,500
selling price TZS110 per Chair
direct materials TZS30 per chair
direct labour TZS40 per chair
fixed production overheads TZS100,000
The directors ask for your help in producing profit statements using the marginal costing and
absorption costing methods. They say that they will use ‘the one that shows the higher profit’ to
the company’s bank manager

QUESTION 3

Coffeeworks Limited manufactures coffee machines for domestic use. The management
of the company is considering next year’s production and has asked you to help with
certain financial decisions.
The following information is available:

Selling price (per machine) TZS80

Direct materials (per machine) TZS25
Direct labour (per machine) TZS20
Fixed production overheads TZS270,000 per year

The company is planning to manufacture 15,000 coffee machines next year.

(a) calculate the marginal cost per coffee machine
(b) calculate the absorption cost per coffee machine
(c) prepare a statement of profit or loss to show the profit or loss if 15,000
coffee machines are sold

QUESTION4
Cook-It Limited makes garden barbecues. The management of the company is
considering the production for next year and has asked for help with certain financial
decisions.
The following information is available:

Selling price (per barbecue) TZS90

Direct materials (per barbecue) TZS30
Direct labour (per barbecue) TZS25
Fixed production overheads TZS150,000 per year

The company is planning to manufacture 10,000 barbecues next year.

Required:You are to calculate:

• the marginal cost per barbecue
• the absorption cost per barbecue
• the profit or loss if 10,000 barbecues are sold

Maxxa Limited manufactures one product, the Maxx. For the month of January 20-7 the
following information is available:

Number of units manufactured 4,000

Number of units sold 3,000
Selling price TZS8 per unit
Direct materials for month TZS5,000
Direct labour for month TZS9,000
Fixed production overheads for month TZS6,000

There was no finished goods inventory at the start of the month. Both direct Materials and direct
labour are variable costs.

Required:
You are to produce statements of profit or loss using marginal costing and absorption costing
methods.

QUESTION 5
Activtoys Limited commenced business on 1 January 20-1. It manufactures the ‘Activ’, an
outdoor climbing frame. Information on the first year’s trading is as follows:
Number of climbing frames manufactured
1,500 Number of climbing frames sold
1,300
Selling price TZS125 per frame
Direct materials TZS25 per frame
Direct labour TZS30 per frame
Fixed production overheads TZS82,500

Required
a. The directors ask for your help in producing statements of profit or loss using the
marginal costing and absorption costing methods. They say that they will use “the one
that gives the higher profit” to show to the company’s bank manager.

b. Write a note to the directors explaining the reason for the different profit figures and
commenting on their statement.

QUESTION 6
Durning Limited manufactures one product, the Durn. For the month of April 20-4 the
following information is available:

Number of units manufactured 10,000

Number of units sold 8,000
Selling price TZS4 per
unit
Direct materials for month TZS8,000
Direct labour for month TZS16,000
Fixed production overheads for TZS10,000
month

There was no finished goods inventory at the start of the month. Both direct
materials and direct labour are variable costs.

Required
(a) produce statements of profit or loss for April 20-4, using:
• marginal costing
• absorption costing
(b) explain briefly the reason for the difference between recorded profits under
the alternative costing methods
SOLUTION QUESTION 1

Working 1: Calculate full production cost TZS

Direct materials 8.00
Direct labour 5.00
Variable production o/h’s 3.00
Fixed production o/h’s[TZS4,000/400 units] 10.00
Full production cost 26.00

Working 2: Calculate value of inventory and production (These must be valued at

TZS26 p/u]

Opening inventory Production Closing inventory

May 0 [500 units x TZS26] = [200 units x TZS26] =
TZS13,000 TZS5,200
June [200 units x TZS26] = [380 units x 26] = [80 units x TZS26] =
TZS5,200 TZS9,880 TZS2,080

Working 3: Under/over absorbed fixed production overhead

May June
Actual fixed prod o/h TZS4,000 TZS4,000
Fixed o/h absorbed TZS5,000 [500*TZS10] TZS3,800 [380 units *TZS10]
TZS1,000 (over absorbed) TZS200 (under absorbed)

Absorption costing profit statement

May May June June

TZS TZS TZS TZS
Sales 15,000 25,000
Less cost of sales
Opening inventory (w2) 0 5,200
Production (w2) 13,000 9,880
Closing inventory (w2) (5,200) (7,800) (2,080) (13,000)

(Under)/over absorbed Fixed prod o/h (w3) 1,000 (200)

Gross profit 8,200 11,800
Less expenses
Variable sales commission 750 1,250
Fixed administration 2,000 2,000
Fixed selling 4,000 (6,750) 4,000 (7,250)
Net profit 1,450 4,550
Marginal Costing

Working 1: Calculate the variable production cost TZS

Direct materials 8.00
Direct labour 5.00
Variable production o/h’s 3.00
Variable production cost 16.00

Working 2: Calculate value of inventory and production (These must be valued at

TZS16 p/u]

Opening inventory Production Closing inventory

May 0 [500 units x [200 units x TZS16]
TZS16]= =
TZS8,000 TZS3,200
June [200 units x TZS16] [380 units x TZS16] [80 units x TZS16] =
= = TZS1,280
TZS3,200 TZS6,080

Marginal costing profit statement

May May June June

TZS TZS TZS TZS
Sales 15,000 25,000
Less variable costs
Opening inventory (w2) 0 3,200
Production (w2) 8,000 6,080
Closing inventory (w2) (3,200) (4,800) (1,280) (8,000)

Variable sales commission (750) (1,250)

Contribution 9,450 15,750
Less fixed costs
Fixed production 4,000 4,000
Fixed administration 2,000 2,000
Fixed selling 4,000 (10,000) 4,000 (10,000)
Profit (550) 5,750

Difference in profit figures calculated under absorption and marginal costing

principles:
The difference between the profit figures calculated under absorption and marginal
costing principles is caused by the treatment of fixed production overheads. In marginal
costing the full amount of fixed production overheads is written off in the period that it
occurs. In absorption part of the fixed production overheads is carried between
accounting periods as part of inventory valuations.
Reconciliation of profit figures
 May June
Profit under absorption TZS1,450 TZS4,550

Difference in units of inventory

* fixed production overhead p/u (TZS2,000) [200 units * TZS1,200 [120 units *
TZS10] TZS10]
Profit under marginal costing (TZS550) TZS5,750

When the number of units produced is higher than the number of units sold absorption
profit will be higher than marginal profit
When the number of units produced is less than the number of units sold absorption
profit will be lower than marginal profit.

SOLUTION QUESTION 2