Marginal Costing and Absorption Costing PDF

BM2209 MARGINAL COSTING AND ABSORPTION COSTING Marginal Costing Marginal cost is incurred for producing an additional unit of output. It is a principle whereby marginal expenditures of cost units are determined. In this method, only the variable costs are charged to cos...

BM2209 MARGINAL COSTING AND ABSORPTION COSTING Marginal Costing Marginal cost is incurred for producing an additional unit of output. It is a principle whereby marginal expenditures of cost units are determined. In this method, only the variable costs are charged to cost units. EXAMPLE: ABC Corporation is producing 1,000 units of combat boots each month with a total cost of P4,000. The total cost increases to P4,090 after producing additional 30 outputs. Determine the marginal cost associated with the production of ABC Corporation. PROCEDURE: Step 1. Calculate the marginal cost using the following formula: 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 𝑃4,090 − 𝑃4000 𝑃90 𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑐𝑜𝑠𝑡 = = = = 𝑷𝟑 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑜𝑢𝑡𝑝𝑢𝑡 1,030 − 1,000 30 Absorption Costing Absorption costing is a principle whereby fixed and variable costs are allotted to cost units. Under this system, cost per unit includes fixed expenses and variable costs. Absorption costing is called “product costing” or “full costing technique.” EXAMPLE: XYZ Enterprise is selling handmade baskets in a nearby province. The company owner desires to identify their basket production's marginal and total cost. The following cost per unit associated with their basket production is available: Direct materials P2 Direct wages 2 Variable overhead 2 Fixed overhead 3 PROCEDURE: Step 1. Calculate the marginal cost of production using the following formula: 𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑐𝑜𝑠𝑡 = 𝐷𝑖𝑟𝑒𝑐𝑡 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙 + 𝐷𝑖𝑟𝑒𝑐𝑡 𝑊𝑎𝑔𝑒𝑠 + 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 = 𝑃2 + 2 + 2 = 𝑷𝟔 Step 2. Calculate the total product cost using the following formula: 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 𝑐𝑜𝑠𝑡 = 𝐷𝑖𝑟𝑒𝑐𝑡 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙 + 𝐷𝑖𝑟𝑒𝑐𝑡 𝑊𝑎𝑔𝑒𝑠 + 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 + 𝐹𝑖𝑥𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 = 𝑃2 + 2 + 2 + 3 = 𝑷𝟗 Contribution to Gross Margin The gross margin or contribution is the difference between sales and the marginal cost of sales. The following are the specific definitions of contribution: Contribution per unit. It is the difference between the selling price of a product or service and its marginal cost. Contribution in total. It is the difference between the sales value and the marginal cost of transactions. 08 Handout 1 *Property of STI  [email protected] Page 1 of 4  BM2209 The contribution of gross margin represents the amount each unit contributes towards absorbing fixed costs and generating profit. It is determined by deducting the variable cost from sales revenue for a business segment. Contribution includes both fixed cost and profit. The marginal costing technique assumes that the contribution provides a pool wherein fixed cost is met, and surplus represents the net profit or margin. Products may be sold under different situations such as profit or loss, or no profit and no loss. As such, the character of contributions has the following compositions under various conditions: Selling price containing profit (sales at a profit): Contribution = Fixed cost + Profit Selling price at cost (no profit and no loss): Contribution = Fixed cost Selling price at a loss (sales at a loss): Contribution = Fixed cost – Loss The following are the key terms associated with the computation of contribution margin: The total cost of production. It is the overall cost of producing a unit of output, which includes direct materials, direct labor, and overheads. Sales value. It is the amount of money equivalent to a sold product or service. Opening stock. It is the value of goods available for sale at the beginning of an inventory period. Closing stock. It is the value of goods available for sale at the end of an inventory period. Gross profit. It is a company's revenue after deducting the costs associated with making and selling goods or the costs related to providing services. EXAMPLE: Antares Inc. desires to determine the gross margin associated with their production using marginal and absorption costing. The operating statistics of the company were as follows: Total units produced 5,000 units Total units sold 4,000 units Selling price per unit P10 Total fixed overheads P15,000 The following are the cost structure per unit of output produced: Direct Materials P2 Direct Wages 2 Variable Overhead 2 Fixed Overhead 3 PROCEDURE: Step 1. Calculate the closing stock using the following formula: 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 = 𝑈𝑛𝑖𝑡𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑 − 𝑈𝑛𝑖𝑡𝑠 𝑠𝑜𝑙𝑑 = 5,000 𝑢𝑛𝑖𝑡𝑠 − 4,000 𝑢𝑛𝑖𝑡𝑠 = 𝟏, 𝟎𝟎𝟎 𝒖𝒏𝒊𝒕𝒔 Step 2. Calculate the marginal cost and total cost of production using the following formula for marginal and absorption costing: Marginal Costing: 𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 = 𝐷𝑖𝑟𝑒𝑐𝑡 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠 + 𝐷𝑖𝑟𝑒𝑐𝑡 𝑤𝑎𝑔𝑒𝑠 + 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 = 𝑃2 + 2 + 2 = 𝑷𝟔 08 Handout 1 *Property of STI  [email protected] Page 2 of 4  BM2209 Absorption Costing: 𝑇𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑐𝑜𝑠𝑡 = 𝐷𝑖𝑟𝑒𝑐𝑡 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠 + 𝐷𝑖𝑟𝑒𝑐𝑡 𝑤𝑎𝑔𝑒𝑠 + 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 + 𝐹𝑖𝑥𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 = 𝑃2 + 2 + 2 + 3 = 𝑷𝟗 Step 3. Determine the amount of sales value using the following formula: 𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 𝑣𝑎𝑙𝑢𝑒 = 𝑈𝑛𝑖𝑡𝑠 𝑠𝑜𝑙𝑑 × 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = 4,000 × 𝑃10 = 𝑷𝟒𝟎, 𝟎𝟎𝟎 Step 4. Determine the opening and closing stock by multiplying the units produced and the value of the computed closing stock by the marginal cost and total cost of production: Marginal Costing: 𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 = 𝑈𝑛𝑖𝑡𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑 × 𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 = 5,000 × 𝑃6 = 𝑷𝟑𝟎, 𝟎𝟎𝟎 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 = (𝑈𝑛𝑖𝑡𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑 − 𝑈𝑛𝑖𝑡𝑠 𝑠𝑜𝑙𝑑) × 𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 = 1,000 × 𝑃6 = 𝑷𝟔, 𝟎𝟎𝟎 Absorption Costing: 𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 = 𝑈𝑛𝑖𝑡𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑 × 𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 = 5,000 × 𝑃9 = 𝑷𝟒𝟓, 𝟎𝟎𝟎 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 = (𝑈𝑛𝑖𝑡𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑 − 𝑈𝑛𝑖𝑡𝑠 𝑠𝑜𝑙𝑑) × 𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 = 1,000 × 𝑃9 = 𝑷𝟗, 𝟎𝟎𝟎 Step 5. Determine the amount of contribution margin and gross profit using the following formulas: Marginal Costing: 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 = 𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 𝑣𝑎𝑙𝑢𝑒 − (𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 − 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘) = 𝑃40,000 − (𝑃30,000 − 𝑃6,000) = 𝑃40,000 − 𝑃24,000 = 𝑷𝟏𝟔, 𝟎𝟎𝟎 𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 = 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 − 𝐹𝑖𝑥𝑒𝑑 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 = 𝑃16,000 − 𝑃15,000 = 𝑷𝟏, 𝟎𝟎𝟎 08 Handout 1 *Property of STI  [email protected] Page 3 of 4  BM2209 Absorption Costing: 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 𝑜𝑟 𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 = 𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 𝑣𝑎𝑙𝑢𝑒 − (𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 − 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘) = 𝑃40,000 − (𝑃45,000 − 𝑃9,000) = 𝑃40,000 − 𝑃36,000 = 𝑷𝟒, 𝟎𝟎𝟎 Key points: Marginal and absorption costing primarily differ in the treatment of fixed costs. Absorption costing considers the fixed cost in its inventory value, whereas marginal costing only considers the direct materials, direct wages, and variable overhead. References: Lalitha, R. & Rajasekaran, V. (2010). Costing accounting. Pearson. Rante, G. A. (2016). Cost accounting. Millenium Books, Inc. 08 Handout 1 *Property of STI  [email protected] Page 4 of 4