Traditional costing, Absorption costing, Variable costing and ABC

Assalamualaikum,

Please refer to the attachment regarding the notes and some of the illustration of the said topic. Remember it is an exam material. Download the notes as the one that I put in the flipsnack will not last that long as I would be progressing to new topic using the same application.

Management accounting notes for Absorption, Variable and ABC

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Absorption and Marginal Costing - Unit cost and Income Statement

Assalamualaikum,

In order for you to have more understanding regarding the topic, let's do some simple exercise.

Ainnazuha Scarf presents the following data for year 2019;

·        Opening inventory: 0 Units

·        Sales: 8,000 Units @ RM950

·        Production: 10,000 Units

·        Closing inventory: 2,000 Units

·        Direct materials: RM240

·        Direct labour: RM280

·        Variable manufacturing overhead expenses: RM100

·        Variable selling and administrative expenses: RM40

·        Fixed manufacturing overhead expenses: RM1,200,000

·        Fixed selling and administrative expenses: RM800,000

Required: 

Using the data given above, 

1. Compute the unit product cost of one bike under:

    - Absorption costing system.

    - Variable costing system.

2. Income statement

   - Absorption costing system.

   - Variable costing system.

Marginal Costing vs Absorption Costing : Exercise

During 2018, Fadhil Works Inc had RM10,000 sales commission, RM2,000 in administrative costs of which RM800 is fixed. They sold 8,500 units and produced 10,000 units. Their selling price per unit was RM45, direct materials was RM10, direct labour RM7 and variable overhead was M3.50. fixed overhead amounted to RM7,500.

Prepare an income statement under Variable costing and Absorption costing.
Show the difference in net profit between the two methods.

Marginal Costing

Marginal Costing

Marginal cost is the variable cost of one unit of product or service. 

Marginal costing is an alternative method of costing to absorption costing. In marginal costing, only variable costs are charged as a cost of sale and a contribution is calculated (sales revenue minus variable cost of sales). Closing inventories of work in progress or finished goods are valued at marginal (variable) production cost. Fixed costs are treated as a period cost, and are charged in full to the profit and loss account of the accounting period in which they are incurred.

The marginal production cost per unit of an item usually consists of the following. 

•Direct materials 

•Direct labour 

•Variable production overheads 

Direct labour costs might be excluded from marginal costs when the work force is a given number of employees on a fixed wage or salary. Even so, it is not uncommon for direct labour to be treated as a variable cost, even when employees are paid a basic wage for a fixed working week. If in doubt, you should treat direct labour as a variable cost unless given clear indications to the contrary. Direct labour is often a step cost, with sufficiently short steps to make labour costs act in a variable fashion. 

The marginal cost of sales usually consists of the marginal cost of production adjusted for inventory movements plus the variable selling costs, which would include items such as sales commission, and possibly some variable distribution costs.

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 of fundamental importance in marginal costing, and the term 'contribution' is really short for 'contribution towards covering fixed overheads and making a profit'.

The principles of marginal costing

The principles of marginal costing are as follows. 

a)  Period fixed costs are the same, for any volume of sales and production (provided that the level of activity is within the 'relevant range'). Therefore, by selling an extra item of product or service the following will happen. 

    • Revenue will increase by the sales value of the item sold. 

    • Costs will increase by the variable cost per unit. 

  • Profit will increase by the amount of contribution earned from the extra item. 

b)  Similarly, if the volume of sales falls by one item, the profit will fall by the amount of contribution earned from the item. 

c)  Profit measurement should therefore be based on an analysis of total contribution. Since fixed costs relate to a period of time, and do not change with increases or decreases in sales volume, it is misleading to charge units of sale with a share of fixed costs. Absorption costing is therefore misleading, and it is more appropriate to deduct fixed costs from total contribution for the period to derive a profit figure. 

d)  When a unit of product is made, the extra costs incurred in its manufacture are the variable production costs. Fixed costs are unaffected, and no extra fixed costs are incurred when output is increased. It is therefore argued that the valuation of closing inventories should be at variable production cost (direct materials, direct labour, direct expenses (if any) and variable production overhead) because these are the only costs properly attributable to the product.

Time to read, understand and explain..... Management Accounting

Hear ye.... Hear ye....


For Management Accounting students....

Starting from 26 November 2018, you will be taking ACC2236 as one your core subject for DIA. So here is what you gonna do. READ! UNDERSTAND! AND EXPLAIN!

Your first task is Marginal costing and Absorption costing. Read those and we will discuss them in class. I want you to tell me what is it.

Meanwhile, you may browse thru this blog and find something useful. Okay?

Variable and Absorption Costing

JUST KEEP ON STUDYING ACC2236

A group of anti-social formed a company producing a product called “Deaf & Ego”. The product has a selling price of RM60 per unit. The information of the product is as below;

	RM
Direct material -      Mute -      Snub -      Selfish	3kg@RM1.20/kg 2kg@RM0.80/kg 1kg@RM4.60/kg
Direct labour -      Skilled -      Semi-skilled	RM5/hour RM3/hour
Direct expenses	RM2/unit
Variable selling and administration overheads	RM3/unit
Fixed production overhead	30,000
Fixed selling and administration overheads	15,000
	Units
Units produced	32,000
Budgeted production units	40,000
Units sold	28,000

The product took 2 hours to produce by the skilled labour and 2.5 hours by the semi-skilled labour. The marketing department had spent RM25,000 to promote the product but the staff wouldn’t care less about the product.

Required:

1.      Prepare the income statement under the variable costing and absorption costing system for the four periods ending December 2018.
2.      What is the Break-even point in units for the above product.

Absorption and Marginal Costing Exercise

Exercise - Marginal Costing

Nadhyra Enterprise produces a head scarf called Tudungku which has a selling price of RM48 per unit. The cost of producing the product for each quarter is as below;

	RM
Direct material - Cloth A                       - Cloth B	7 4
Direct labour	6
Direct expenses	3
Fixed production overhead	30,000
Variable selling and administration overheads	2
Fixed selling and administration overheads	18,000

Actual production for the period is 30,000 scarves and she managed to sell about 28,000 of them.

Prepare the income statement under the variable costing and absorption costing system for the four periods ending December 2018.

Variable and Absorption Costing

Dear students....

This is a very good video to watch and understand. Hope it will benefited to you guys.

Part 1

Part 2

Part 3

Exercise

ACC2236 - Absorption vs Variable Costing

See this also...very interesting

ACC2236 - Variable Costing

Variable costing

Variable costing is a methodology that only assigns variable costs to inventory. This approach means that all overhead costs are charged to expense in the period incurred, while direct materials and variable overhead costs are assigned to inventory. There are no uses for variable costing in financial reporting, since the accounting frameworks (such as GAAP and IFRS) require that overhead also be allocated to inventory. Consequently, this methodology is only used for internal reporting purposes. However, it is quite commonly used in this role, where variable costs are used to:

• Conduct breakeven analysis to determine the sales level at which a business earns a zero profit.
• Establish the lowest possible cost at which a product can be sold.
• Formulate internal financial statements into a contribution margin format (which must be adjusted before they can be issued to outside parties).

When variable costing is used, the gross margin reported from a revenue-generating transaction is higher than under an absorption costingsystem, since no overhead allocation is charged to the sale. Though this does mean that the reported gross margin is higher, it does not mean that net profits are higher - the overhead is charged to expense lower in the income statement instead. However, this is only the case when the level of production matches sales. If production exceeds sales, absorption costing will result in a higher level of profitability, since some of the allocated overhead will reside in the inventory asset, rather than being charged to expense in the period. The reverse situation occurs when sales exceed production.

Example

Mark works as an accountant at a leading manufacturing company that produces equipment for pediatric private practice. He is asked to calculate the operating income using the direct costing and the absorption costing methods and compare them. Under the direct costing method, Mark calculates the variable cost of goods sold at 50% of sales to find the product margin, and he deducts the variable expenses to find the contribution margin.

Hence, the fixed manufacturing overheads are allocated against sales during the period in which they are incurred. Also, variable costs comprise of direct materials, direct labor, and variable manufacturing overheads. After deducting the fixed costs from the contribution margin, Mark finds that the company’s operating income is $100,000.

Under the absorption costing method, Mark calculates the cost of goods sold at 70% of sales to find the gross margin, and he deducts the operating expenses (which are the sum of variable expenses and fixed expenses under the indirect costing method), to find that the company’s operating income is $100,000.

Hence, with both methods, he arrives at the same conclusion, but the difference is in the way each method allocates the fixed manufacturing overheads on the income statement.

Summary Definition

Define Variable Costing: Variable costing means a method of accounting for production expenses where all variable costs are included in the product cost during the period.

taken from: https://www.myaccountingcourse.com/accounting-dictionary/variable-costing