1Absorption and marginal costing
2JOIN KHALID AZIZ FRESH CLASSES FOR ICAP MODULED…COST ACCOUNTING REGISTER YOUR SELF NOW COMPLETION OF SYLLABUS WITHACCE...
3JOIN KHALID AZIZ FRESH CLASSES FOR ICAP MODULEB…FINANCIAL ACCOUNTING REGISTER YOUR SELF NOW. COMPLETION OF SYLLABUS WI...
4Introduction Before we allocate all manufacturing coststo products regardless of whether they arefixed or variable. This...
5Definition Absorption costing Marginal costing
6Absorption costing It is costing system which treats allmanufacturing costs including both thefixed and variable costs a...
7Marginal costing It is a costing system which treats only thevariable manufacturing costs as productcosts. The fixed man...
8CostManufacturing cost Non-manufacturing costDirectMaterialsDirectLabourOverheadsFinished goods Cost of goods soldPeriod ...
9Presentation of costs on incomestatement
10Trading and profit ans loss accountAbsorption costing Marginal costing$ $Sales X Sales XLess: Cost of goods sold X Less:...
11Example
12A company started its business in 2005. The following informationWas available for January to March 2005 for the company...
13 Required: Prepare absorption and marginal costingstatements for the three months
14Absorption costing
15January February March$ $ $Sales 100000 80000 110000Less: cost of good sold ($65) 65000 52000 7150028000 38500Adjustment...
16Marginal costing
17January February March$ $ $Sales 100000 80000 110000Less: Variable cost of goodsold ($35) 35000 28000 385500Product cont...
18Wk1:Standard fixed overhead rate= Budgeted total fixed factory overheadsBudgeted number of units produced= $300001000 un...
19Wk 3:(Under-)/Over-absorption of fixed factory overheads:January February March$ $ $Fixed overhead 30000 39000 27000Fixe...
20Difference between absorptionand marginal costing
21Absorption costing Marginal costingTreatment forfixedmanufacturingoverheadsFixedmanufacturingoverheads aretreated as pro...
22Absorption costing Marginal costingValue ofclosing stockHigh value ofclosing stock will beobtained as somefactory overhe...
23Absorption costing Marginal costingReportedprofitIf the production = Sales, AC profit = MC ProfitIf Production > Sales, ...
24Argument for absorption costing
25 Compliance with the generally acceptedaccounting principles Importance of fixed overheads for production Avoidance o...
26Arguments for marginal costing
27 More relevance to decision-making Avoidance of profit manipulation Marginal costing can avoid profit manipulation by...
28Break-even analysis
29Definition Breakeven analysis is also known as cost-volume profit analysis Breakeven analysis is the study of therelat...
30Application Breakeven analysis can be used todetermine a company’s breakeven point(BEP) Breakeven point is a level of ...
31Assumption of breakeven pointanalysis Relevant range The relevant range is the range of an activity overwhich the fixe...
32 Sales revenue The total revenue will increase with theincreasing number of units produced
33Total costVariable costFixed costCost $Sales (units)Sales revenueTotal Cost/Revenue $Sales (units)Total costProfitBEP
34Calculation method
35Calculation method Breakeven point Target profit Margin of safety Changes in components of breakevenanalysis
36Breakeven point
37Calculation method Contribution is defined as the excess ofsales revenue over the variable costs The total contributio...
38FormulaBreakeven pointFixed costContribution per unitSales revenue at breakeven point= Breakeven point *selling price=
39Alternative method:Sales revenue at breakeven pointContribution required to breakevenContribution to sales ratio=Breakev...
40Example Selling price per unit $12 Variable cost per unit $3 Fixed costs $45000Required: Compute the breakeven point
41Breakeven point in units = Fixed costsContribution per unit= $45000$12-$3= 5000 unitsSales revenue at breakeven point = ...
42Alternative methodContribution to sales ratio $9 /$12 *100% = 75%Sales revenue at breakeven point= Contribution required...
43Target profit
44FormulaNo. of units at target profitFixed cost + Target profitContribution per unit=Required sales revenueFixed cost + T...
45Example Selling price per unit $12 Variable cost per unit $3 Fixed costs $45000 Target profit $18000Required: Compu...
46No. of units at target profitFixed cost + Target profitContribution per unit=$45000 + $18000$12 - $3== 7000 unitsRequire...
47Alternative methodRequired sales revenueFixed cost + Target profitContribution to sales ratio=$45000 + $1800075%== $8400...
48Margin of safety
49Margin of safety Margin of safety is a measure of amount bywhich the sales may decrease before acompany suffers a loss....
50FormulaMargin of safety= Margin of safetyBudget sales level*100%Margin of safety= Budget sales level – breakeven sales l...
51Sales revenueTotal Cost/Revenue $Sales (units)Total costProfitBEPMargin of safety
52Example The breakeven sales level is at 5000 units.The company sets the target profit at$18000 and the budget sales lev...
53Margin of safety= Budget sales level – breakeven sales level= 7000 units – 5000 units= 2000 unitsMargin of safety= Margi...
54Changes in components ofbreakeven point
55Example Selling price per unit $12 Variable price per unit $3 Fixed costs $45000 Current profit $18000
56 If the selling prices is raised from $12 to$13, the minimum volume of sales requiredto maintain the current profit wil...
57 If the fixed cost fall by $5000 but thevariable costs rise to $4 per unit, theminimum volume of sales required tomaint...
58Limitation of breakeven point
59Limitations of breakeven analysis Breakeven analysis assumes that fixed cost,variable costs and sales revenue behave in...
60 It is assumed that all production is sold.The breakeven chart does not take thechanges in stock level into account Br...
61JOIN KHALID AZIZ ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS,B.COM. FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4ICAP MODULE B,...
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Absorptionandmarginalcosting 120601013706-phpapp02

  1. 1. 1Absorption and marginal costing
  2. 2. 2JOIN KHALID AZIZ FRESH CLASSES FOR ICAP MODULED…COST ACCOUNTING REGISTER YOUR SELF NOW COMPLETION OF SYLLABUS WITHACCENTUATE ON BASIC CONCEPTS.
  3. 3. 3JOIN KHALID AZIZ FRESH CLASSES FOR ICAP MODULEB…FINANCIAL ACCOUNTING REGISTER YOUR SELF NOW. COMPLETION OF SYLLABUS WITHACCENTUATE ON BASIC CONCEPTS.
  4. 4. 4Introduction Before we allocate all manufacturing coststo products regardless of whether they arefixed or variable. This approach is knownas absorption costing/full costing However, only variable costs are relevantto decision-making. This is known asmarginal costing/variable costing
  5. 5. 5Definition Absorption costing Marginal costing
  6. 6. 6Absorption costing It is costing system which treats allmanufacturing costs including both thefixed and variable costs as product costs
  7. 7. 7Marginal costing It is a costing system which treats only thevariable manufacturing costs as productcosts. The fixed manufacturing overheadsare regarded as period cost
  8. 8. 8CostManufacturing cost Non-manufacturing costDirectMaterialsDirectLabourOverheadsFinished goods Cost of goods soldPeriod costProfit and loss accountAbsorption CostingCostManufacturing cost Non-manufacturing costDirectMaterialsDirectLabourVariableOverheadsFinished goods Cost of goods soldPeriod costProfit and loss accountMarginal CostingFixedoverhead
  9. 9. 9Presentation of costs on incomestatement
  10. 10. 10Trading and profit ans loss accountAbsorption costing Marginal costing$ $Sales X Sales XLess: Cost of goods sold X Less: Variable cost ofGoods sold XGross profit X Product contribution margin XLess: Expenses Less: variable non- manufacturingSelling expenses X expensesAdmin. expenses X Variable selling expenses XOther expenses X X Variable admin. expenses XOther variable expenses XTotal contribution expenses XLess: ExpensesFixed selling expenses XFixed admin. expenses XOther fixed expenses XNet Profit X Net Profit XVariable and fixed manufacturing
  11. 11. 11Example
  12. 12. 12A company started its business in 2005. The following informationWas available for January to March 2005 for the company that producedA single product:$Selling price pre unit 100Direct materials per unit 20Direct Labour per unit 10Fixed factory overhead per month 30000Variable factory overhead per unit 5Fixed selling overheads 1000Variable selling overheads per unit 4Budgeted activity was expected to be 1000 units each monthProduction and sales for each month were as follows:Jan Feb MarchUnit sold 1000 800 1100Unit produced 1000 1300 900
  13. 13. 13 Required: Prepare absorption and marginal costingstatements for the three months
  14. 14. 14Absorption costing
  15. 15. 15January February March$ $ $Sales 100000 80000 110000Less: cost of good sold ($65) 65000 52000 7150028000 38500Adjustment for Over-/(under)Absorption of factory overhead 9000 (3000)Gross profit 35000 37000 35500Less: ExpensesFixed selling overheads 1000 1000 1000Variable selling overheads 4000 3200 4400Net profit 30000 32800 30100
  16. 16. 16Marginal costing
  17. 17. 17January February March$ $ $Sales 100000 80000 110000Less: Variable cost of goodsold ($35) 35000 28000 385500Product contribution margin 65000 52000 71500Less: Variable selling overhead4000 3200 4400Total contribution margin 61000 48800 67100Less: Fixed ExpensesFixed factory overhead 30000 30000 30000Fixed selling overheads 1000 1000 1000Net profit 30000 32800 30100
  18. 18. 18Wk1:Standard fixed overhead rate= Budgeted total fixed factory overheadsBudgeted number of units produced= $300001000 units= $30 unitsWk 2:Production cost per unit under absorption costing:$Direct materials 20Direct labour 10Fixed factory overhead absorbed 30Variable factory overheads 565Back
  19. 19. 19Wk 3:(Under-)/Over-absorption of fixed factory overheads:January February March$ $ $Fixed overhead 30000 39000 27000Fixed overheads incurred 30000 30000 300000 9000 (3000)1000*$30 1300*$30 900*$30Wk 4:Variable production cost per unit under marginal costing:$Direct materials 20Direct labour 10Variable factory overhead 535No fixed factory overheadBack
  20. 20. 20Difference between absorptionand marginal costing
  21. 21. 21Absorption costing Marginal costingTreatment forfixedmanufacturingoverheadsFixedmanufacturingoverheads aretreated as productcosting. It isbelieved thatproducts cannot beproduced withoutthe resourcesprovided by fixedmanufacturingoverheadsFixed manufacturingoverhead are treatedas period costs. It isbelieved that only thevariable costs arerelevant to decision-making.Fixed manufacturingoverheads will beincurred regardlessthere is production ornot
  22. 22. 22Absorption costing Marginal costingValue ofclosing stockHigh value ofclosing stock will beobtained as somefactory overheadsare included asproduct costs andcarried forward asclosing stockLower value ofclosing stock thatincluded the variablecost only
  23. 23. 23Absorption costing Marginal costingReportedprofitIf the production = Sales, AC profit = MC ProfitIf Production > Sales, AC profit > MC profitAs some factory overhead will be deferred asproduct costs under the absorption costingIf Production < Sales, AC profit < MC profitAs the previously deferred factory overheadwill be released and charged as cost of goodssold
  24. 24. 24Argument for absorption costing
  25. 25. 25 Compliance with the generally acceptedaccounting principles Importance of fixed overheads for production Avoidance of fictitious profit or loss During the period of high sales, the production issmall than the sales, a smaller number of fixedmanufacturing overheads are charged and a highernet profit will be obtained under marginal costing Absorption costing is better in avoiding thefluctuation of profit being reported in marginalcosting
  26. 26. 26Arguments for marginal costing
  27. 27. 27 More relevance to decision-making Avoidance of profit manipulation Marginal costing can avoid profit manipulation byadjusting the stock level Consideration given to fixed cost In fact, marginal costing does not ignore fixed costsin setting the selling price. On the contrary, itprovides useful information for break-even analysisthat indicates whether fixed costs can be convertedwith the change in sales volume
  28. 28. 28Break-even analysis
  29. 29. 29Definition Breakeven analysis is also known as cost-volume profit analysis Breakeven analysis is the study of therelationship between selling prices, salesvolumes, fixed costs, variable costs andprofits at various levels of activity
  30. 30. 30Application Breakeven analysis can be used todetermine a company’s breakeven point(BEP) Breakeven point is a level of activity atwhich the total revenue is equal to the totalcosts At this level, the company makes no profit
  31. 31. 31Assumption of breakeven pointanalysis Relevant range The relevant range is the range of an activity overwhich the fixed cost will remain fixed in total and thevariable cost per unit will remain constant Fixed cost Total fixed cost are assumed to be constant in total Variable cost Total variable cost will increase with increasingnumber of units produced
  32. 32. 32 Sales revenue The total revenue will increase with theincreasing number of units produced
  33. 33. 33Total costVariable costFixed costCost $Sales (units)Sales revenueTotal Cost/Revenue $Sales (units)Total costProfitBEP
  34. 34. 34Calculation method
  35. 35. 35Calculation method Breakeven point Target profit Margin of safety Changes in components of breakevenanalysis
  36. 36. 36Breakeven point
  37. 37. 37Calculation method Contribution is defined as the excess ofsales revenue over the variable costs The total contribution is equal to total fixedcost
  38. 38. 38FormulaBreakeven pointFixed costContribution per unitSales revenue at breakeven point= Breakeven point *selling price=
  39. 39. 39Alternative method:Sales revenue at breakeven pointContribution required to breakevenContribution to sales ratio=Breakeven point in unitsSales revenue at breakeven pointSelling price=Contribution per unitSelling price per unit
  40. 40. 40Example Selling price per unit $12 Variable cost per unit $3 Fixed costs $45000Required: Compute the breakeven point
  41. 41. 41Breakeven point in units = Fixed costsContribution per unit= $45000$12-$3= 5000 unitsSales revenue at breakeven point = $12 * 5000 = $60000
  42. 42. 42Alternative methodContribution to sales ratio $9 /$12 *100% = 75%Sales revenue at breakeven point= Contribution required to break evenContribution to sales ratio= $4500075%= $60000Breakeven point in units = $60000/$12 = 5000 units
  43. 43. 43Target profit
  44. 44. 44FormulaNo. of units at target profitFixed cost + Target profitContribution per unit=Required sales revenueFixed cost + Target profitContribution to sales ratio=
  45. 45. 45Example Selling price per unit $12 Variable cost per unit $3 Fixed costs $45000 Target profit $18000Required: Compute the sales volume required to achievethe target profit
  46. 46. 46No. of units at target profitFixed cost + Target profitContribution per unit=$45000 + $18000$12 - $3== 7000 unitsRequired to sales revenue = $12 *7000= $84000
  47. 47. 47Alternative methodRequired sales revenueFixed cost + Target profitContribution to sales ratio=$45000 + $1800075%== $84000Units sold at target profit = $84000 /$12 = 7000 units
  48. 48. 48Margin of safety
  49. 49. 49Margin of safety Margin of safety is a measure of amount bywhich the sales may decrease before acompany suffers a loss. This can be expressed as a number of unitsor a percentage of sales
  50. 50. 50FormulaMargin of safety= Margin of safetyBudget sales level*100%Margin of safety= Budget sales level – breakeven sales level
  51. 51. 51Sales revenueTotal Cost/Revenue $Sales (units)Total costProfitBEPMargin of safety
  52. 52. 52Example The breakeven sales level is at 5000 units.The company sets the target profit at$18000 and the budget sales level at 7000unitsRequired:Calculate the margin of safety in units andexpress it as a percentage of the budgetedsales revenue
  53. 53. 53Margin of safety= Budget sales level – breakeven sales level= 7000 units – 5000 units= 2000 unitsMargin of safety= Margin of safetyBudget sales level= 20007000= 28.6%*100 %*100 %The margin of safety indicates that the actual sales can fall by2000 units or 28.6% from the budgeted level before losses areincurred.
  54. 54. 54Changes in components ofbreakeven point
  55. 55. 55Example Selling price per unit $12 Variable price per unit $3 Fixed costs $45000 Current profit $18000
  56. 56. 56 If the selling prices is raised from $12 to$13, the minimum volume of sales requiredto maintain the current profit will be:Fixed cost + Target profitContribution to sales ratio=$45000 + $18000$13 - $3= 6300 units
  57. 57. 57 If the fixed cost fall by $5000 but thevariable costs rise to $4 per unit, theminimum volume of sales required tomaintain the current profit will be:Fixed cost + Target profitContribution to sales ratio= $40000 + $18000$12 - $4= 7250 units
  58. 58. 58Limitation of breakeven point
  59. 59. 59Limitations of breakeven analysis Breakeven analysis assumes that fixed cost,variable costs and sales revenue behave inlinear manner. However, some overheadcosts may be stepped in nature. Thestraight sales revenue line and total costline tent to curve beyond certain level ofproduction
  60. 60. 60 It is assumed that all production is sold.The breakeven chart does not take thechanges in stock level into account Breakeven analysis can provideinformation for small and relatively simplecompanies that produce same product. It isnot useful for the companies producingmultiple products
  61. 61. 61JOIN KHALID AZIZ ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS,B.COM. FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4ICAP MODULE B, B.COM, BBA, MBA & PIPFA. COST ACCOUNTING OF ICMAP STAGE 2,3 ICAPMODULE D, BBA, MBA & PIPFA. CONTACT: 0322-3385752 0312-2302870 R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA,KARACHI, PAKISTAN
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