ABSORPTION & MARGINAL COSTING CHAPTER 9 ABSORPTION & MARGINAL COSTING BY 章意宏 龚铭杨 赵一凝 李宸昊

CHAPTER PREVIEW DL Variable cost DM Variable PHD Marginal costing Fixed cost as a period cost Contribution Methods of costing Principles Variable cost Absortion costing Fixed costs are absorbed into unit costs Inventory level Marginal costing Reconciling profit Inventory valuation Absortion costing Arguments in favour of both marginal and abortion costing

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1.1 Marginal cost and marginal costing Marginal cost is the variable cost of one unit of product or service. Marginal costing only variable costs are charged to production cost,closting stocks are valued at marginal production cost,and fixed cost are treated as a period cost. Marginal cost Variable production overheads Direct materials Direct labour

1.2 Contribution Contribution is an important measure in marginal costing, and it is calculated as the difference between sales value and marginal or variable cost of sales. Contribution is really short for 'contribution towards covering fixed overheads and making a profit'. Contribution information is more useful for decision making than profit information. Contribution=Sales – Marginal costs Profit=Contribution – fixed costs

1.3 The principles Period fixed costs are the same, for any volume of sales and production. If the volume of sales falls by one item, the profit will fall by the amount of contribution. Profit measurement should therefore be based on an analysis of total contribution. When a unit of product is made, the extra costs incurred in its manufacture are the variable production costs,and no extra fixed costs are incurred when output is incresed.

The calculation of profit 02 The calculation of profit

Marginal costing DM Product DL Production Cost 01 Variable Sales and administration overheads PHD Non-Product Product PHD Period Cost Fixed Sales and administration overheads Non-Product

Absorption Costing DM Product DL Production Cost Total PHD Non-Product Sales and administration overheads Period Cost

Compare Marginal costing Absorption costing Closing inventories are valued at marginal production cost. Closing inventories are valued at full production cost. Fixed costs are absorbed into unit costs. Fixed costs are period costs Cost of sales does not include a share of fixed overheads. Cost of sales does include a share of fixed overheads

Formula Budgeted fixed overheads Overhead absorption rate = Budgeted units A Total cost per unit = Variable cost + fixed production cost M Total cost per unit =Variable cost per unit Closing inventory = Opening inventory + production - sales Under–production overheads = (Budgeted – Actual production) × OAR Statements of profit or loss

Statements of profit or loss

No changes in inventory Production = Sales You will notice that there are no difference between the two profits.

03 Reconciling profit

Introduction Profit Inventory level Inventory level Profit Reported profit figures using marginal costing or absorption costing will differ if there is any change in the level of inventories in the period.But once the inventory is equal to zero,different costing methods will calculate the same answer Using absorption costing Inventory level Profit Inventory level Profit

Reconciling profit——a shortcut Marginal cost Cost of sales doesn’t include a share of fixed overhead Absorption cost Cost of sales does include a share of fixed overhead Differences in profits = change in inventory level X overhead absorption rate per unit Points Distinguish which one can get higher profit when inventory level changes

The calculation of profit 04 The calculation of profit

Arguments in favour of both marginal and absorption costing It is 'fair' to share fixed production cost between units of production as such costs are incurred in order to make output   Closing inventories valued in accordance with IAS 2 principles It is easier to determine the profitability of several products by charging a share of fixed overheads to them Where building up inventory is necessary fixed costs should be included in inventory valuations in order to prevent a series of losses from occurring

Arguments in favour of both marginal and abortion costing Marginal costing Simple to operate   No appointments of fixed costs Fixed costs = period costs unchanged at all output volumes Closing inventory realistically valued at variable production cost per unit Size of contribution provides management with useful information about expected profits Absorption costing encourages management to produce goods in order to absorb allocated overheads instead of meeting market demands Under/over absorption of overheads is avoided It is a great aid to decision making