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Subject COMMERCE

Paper No and Title Paper 6 Accounting For Managerial Decisions

Module No and Title Module 23: Marginal costing and absorption costing
(practical)

Module Tag COM_P6_M23

COMMERCE PAPER No.6 : Accounting for Managerial Decisions

MODULE No.23: : Marginal costing and absorption costing (practical)
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TABLE OF CONTENTS
1. 1 Learning Outcomes
2. 2. Introduction
a. Income statement under marginal costing

3. Illustration with explanation for marginal costing

4. Income statement under absorption costing
5. Illustration with explanation for absorption costing.

6. Evaluating difference in profit under marginal and absorption costing

7. Summary

1. Learning Outcomes
After studying this module, you shall be able to

1) Understand income statement using absorption costing technique.

2) Learn income statement using marginal costing technique.
3) Know projected income statement under absorption costing.
4) Learn projected income statement under marginal costing.
5) Evaluate difference in profit under two techniques.

2. Introduction

Marginal and absorption costing practical

Both marginal and absorption costing are technique for calculating income at the
end of the specified period. Period for such calculation depends upon the business
or firm for which income is to be calculated. As we have studied in pervious
module the basic difference in between both the methods lies in the treatment of
the fixed manufacturing overheads.
In variable costing fixed manufacturing overheads are considered to be period cost
that is they are the function time, whereas in absorption costing fixed
manufacturing overheads are considered to be product cost that is it is considered

COMMERCE PAPER No.6 : Accounting for Managerial Decisions

MODULE No.23: : Marginal costing and absorption costing (practical)
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as a function of production. Due to this difference,

there is difference in inventory valuation which indeed causes differences in profit
under both the technique.

Now we will see specific income statement under both the techniques-
a. Income statement under marginal costing-

Sales [A] ----------

--
Less: variable cost of production
Direct material -----------
Direct labour -----------
Variable manufacturing overheads -----------
______ ___________
Cost of goods manufactured -----------
Add: beginning inventory -----------
_______
Cost of goods available for sale -----------
Less: closing inventory -----------
____________________
Cost of goods sold [B] ------------
____________________
[C] Marginal contribution [A - B] ` ----------
---
Less: fixed manufacturing overhead -------------
Variable selling and administrative expenses -------------
Fixed selling and administrative expenses -------------
___________________
Total non-production cost [D] -----------
Net income [C-D] ----------
--

_______________

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MODULE No.23: : Marginal costing and absorption costing (practical)
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Income under marginal costing technique can be

computed by following these steps-
1) Sales value can be computed by multiplying units sold and price per unit.
2) Variable production cost includes costs for direct material, direct labour
and variable overhead. This can be computed by multiplying per unit
material, labour cost and labour overhead cost with units produced
respectively.
3) By adding all the variable costs we shall get cost of production.
4) In cost of production we shall add value of opening inventory to get cost
of goods available for sale.
5) From, cost of goods available for sale, we shall deduct value of closing
inventory to get cost of goods sold.
6) Valuation of opening as well as closing inventory is done through including
only variable production cost, which is considered to be product cost. Here
with variable production cost we mean direct material, direct labour and
variable manufacturing overheads.
7) Now, next step is to get marginal contribution i.e sales value minus variable
cost of goods sold.
8) Now, to get net income we need to deduct all period costs from the
marginal contribution. With period cost here we mean by fixed
manufacturing cost, fixed and variable administrative cost and fixed and
variable selling & distribution costs.

3. Illustration for projected income statement under marginal costing-

Year 2013 2014

Selling price Rs 15/unit Rs15/unit
Quantity sold 20,000 23,000
Production actual 25,000 19,000
Budgeted production 30,000 30,000
Costs:
COMMERCE PAPER No.6 : Accounting for Managerial Decisions
MODULE No.23: : Marginal costing and absorption costing (practical)
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Direct material Rs
3/unit Rs 3/unit
Direct labour Rs 2/unit Rs 2/unit
Variable manufacturing expense Rs 1/unit Rs 1/unit
Fixed manufacturing cost Rs 90,000p.a Rs 90,000p.a
Variable administrative cost Rs 0.50/unit Rs 0.50/unit
Fixed administrative cost Rs 25,000p.a Rs 25,000p.a
Variable selling and distribution cost Rs 1.50/unit Rs 1.50/unit
Fixed selling and distribution cost Rs 35,000p.a Rs 35,000p.a
Compute, under marginal costing actual income for 2013 and projected income for 2014.

Solution:
Income statement under marginal costing-
Year 2013 2014
Sales [A] 3,00,000 3,45,000
Less: variable cost of production
Direct material 75,000 57,000
Direct labour 50,000 38,000
Variable manufacturing overheads 25,000
19,000 ____________________________
Cost of goods manufactured 1,50,000
1,14,000
Add: beginning inventory nil 30,000
______
______________________
Cost of goods available for sale 1,50,000
1,44,000
Less: closing inventory 30,000
6,000

_____________________________
Cost of goods sold [B] 1,20,000
1,38,000

_____________________________
[C] Marginal contribution [A - B] 1,80,000
2,07,000

_____________________________
Less: Variable administrative expenses 10,000 11,500
Variable selling expenses 30,000 34,500
Fixed manufacturing overhead 90,000
90,000
Fixed administrative expenses 25,000
25,000
Fixed selling expenses 35,000
35,000

_____________________________
Total non-production cost [D] 1,90,000 1,96,000
Net income [C-D] (10,000)
11,000

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MODULE No.23: : Marginal costing and absorption costing (practical)
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______ _______________________

Working notes-
2013 2014
1) Sales value- 20,000 X 15 23,000 X 15
= 3,00,000 = 3,45,000
2) Direct material 25,000X3 19,000X3
=75,000 =57,000
3) Direct labour 25,000X2 19,000X2
= 50,000 = 38,000
4) Variable manufacturing exp. 25,000x1 19,000X1
= 25,000 = 19,000
5) Opening inventory* NIL 25,000 + 0 -
20,000
= 5,000 units
6) Closing inventory* 25,000 + 0-20,000 5,000+19,000–
23,000
= 5,000 units = 1,000 units
7) Value of opening inventory NIL 5,000x (3+2+1)
= 30,000
8) Value of closing inventory 5,000 X (3+2+1) 1,000 X (3+2+1)
=30,000 = 6,000
9) Variable administrative cost 20,000 X .50 23,000 X .50
= Rs10,000 = Rs11,500
10) variable selling cost 20,000X1.50 23,000X1.50
= Rs30,000 = Rs 34,500

*closing inventory= opening inventory + production – sale

4. Income statement under absorption costing-

Sales [A] ----------

--
Less: cost of production
Direct material -----------
Direct labour -----------
Variable & fixed manufacturing overheads -----------
______ ___________
Cost of goods manufactured -----------
Add: beginning inventory -----------
_______
Cost of goods available for sale -----------
Less: closing inventory -----------
____________________
Cost of goods sold ------------
Add: under absorbed fixed manufacturing overhead ------------
Less: over absorbed fixed manufacturing overhead ------------
[B]Cost of goods sold at actual -----------
COMMERCE PAPER No.6 : Accounting for Managerial Decisions
MODULE No.23: : Marginal costing and absorption costing (practical)
____________________________________________________________________________________________________

_______________________
[c] Gross profit [A – B] ----------
----
Less: Variable selling and administrative expenses -------------
Fixed selling and administrative expenses -----------
___________________
[D]Total non production cost -----------
Net income [C-D] ----------
--

________________

Income under absorption costing technique can be computed by following

these steps-
1) Sales value can be computed by multiplying units sold and price per unit.
2) Production cost includes costs for direct material, direct labour and fixed
& variable overhead. This can be computed by multiplying per unit
material, labour cost and manufacturing overhead cost with units produced
respectively.
3) By adding all the production costs we shall get cost of production.
4) In cost of production we shall add value of opening inventory to get cost
of goods available for sale.
5) From, cost of goods available for sale, we shall deduct value of closing
inventory to get cost of goods sold.
6) Valuation of opening as well as closing inventory is done through including
both fixed & variable production cost, which is considered to be product
cost. Here with fixed & variable production cost we mean, direct material,
direct labour and fixed & variable manufacturing overheads.
7) As we have absorbed fixed manufacturing overheads for the number of
units produced through some absorption rate, it can be over absorbed or
under absorbed depending on the positive or negative deviation from the

COMMERCE PAPER No.6 : Accounting for Managerial Decisions

MODULE No.23: : Marginal costing and absorption costing (practical)
____________________________________________________________________________________________________

budgeted output. So, if there is over

production then we shall have over absorption which we shall deduct from
cost of goods sold on the other hand if production is less than the budgeted
production, then we shall have under absorption, which we shall add in cost
of goods sold.
8) Now, next step is to get gross profit i.e sales value minus cost of goods
sold actual.
9) Now, to get net income we need to deduct all period costs from the gross
profit. With period cost here we mean by fixed and variable administrative
cost and fixed and variable selling & distribution costs.

5. Illustration for projected income statement under absorption costing-

Year 2013 2014

Selling price Rs 15/unit Rs15/unit
Quantity sold 20,000 23,000
Production actual 25,000 19,000
Budgeted production 30,000 30,000
Costs:
Direct material Rs 3/unit Rs 3/unit
Direct labour Rs 2/unit Rs 2/unit
Variable manufacturing expense Rs 1/unit Rs 1/unit
Fixed manufacturing cost Rs 90,000p.a Rs 90,000p.a
Variable administrative cost Rs 0.50/unit Rs 0.50/unit
Fixed administrative cost Rs 25,000p.a Rs 25,000p.a
Variable selling and distribution cost Rs 1.50/unit Rs 1.50/unit
Fixed selling and distribution cost Rs 35,000p.a Rs 35,000p.a
Compute, under marginal costing actual income for 2013 and projected income for 2014.

Solution:
Income statement under marginal costing-
Year 2013 2014
Sales [A] 3,00,000 3,45,000
Less: variable cost of production
Direct material 75,000 57,000
Direct labour 50,000 38,000

COMMERCE PAPER No.6 : Accounting for Managerial Decisions

MODULE No.23: : Marginal costing and absorption costing (practical)
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Variable manufacturing overheads

25,000 19,000
Fixed manufacturing overhead 75,000 57,000
____________________________
Cost of goods manufactured 2,25,000
1,71,000
Add: beginning inventory nil 45,000
______
______________________
Cost of goods available for sale 2,25,000
2,16,000
Less: closing inventory 45,000
9,000

_____________________________
Cost of goods sold 1,80,000
2,07,000
Add: under absorption of fixed manufacturing exp. 15,000 33,000

_____________________________
[B]Cost of goods sold (actual) 1,95,000 2,40,000
[C] Gross Profit [A - B] 1,05,000
1,05,000

_____________________________
Less: Variable administrative expenses 10,000 11,500
Variable selling expenses 30,000 34,500
Fixed administrative expenses 25,000
25,000
Fixed selling expenses 35,000
35,000

_____________________________
Total non-production cost [D] 1,00,000 1,06,000
Net income [C-D] 5,000
(1,000)
______
_______________________

Working notes-
2013 2014
1) Sales value- 20,000 X 15 23,000 X 15
= 3,00,000 = 3,45,000
2) Direct material 25,000X3 19,000X3
=75,000 =57,000

COMMERCE PAPER No.6 : Accounting for Managerial Decisions

MODULE No.23: : Marginal costing and absorption costing (practical)
____________________________________________________________________________________________________

3) Direct labour 25,000X2

19,000X2
= 50,000 = 38,000
4) Variable manufacturing exp. 25,000x1 19,000X1
= 25,000 = 19,000
5) Fixed manufacturing exp.* 25,000 X 3 19,000 X 3
Rs 75,000 Rs 57,000
6) Under/over absorption Rs90,000-Rs75,000 Rs90,000-
Rs57,000
=Rs 15,000 Rs 33,000
7) Opening inventory* NIL 25,000 + 0 -
20,000
= 5,000 units
8) Closing inventory* 25,000 + 0-20,000 5,000+19,000–
23,000
= 5,000 units = 1,000 units
9) Value of opening inventory NIL 5,000x (3+2+1)
= 30,000
10) Value of closing inventory 5,000 X (3+2+1) 1,000 X (3+2+1)
=30,000 = 6,000
11) Variable administrative cost 20,000 X .50 23,000 X .50
= Rs10,000 = Rs11,500
12) variable selling cost 20,000X1.50 23,000X1.50
= Rs30,000 = Rs 34,500

*closing inventory= opening inventory + production – sale

* Absorption rate for fixed manufacturing overhead= total fixed manufacturing expenses/budgeted
units
90,000/30,000= Rs 3/unit

6. Evaluation of differences in profit under marginal and absorption

costing-

To understand why there is difference in profit under marginal and absorption

costing, we need to fully understand the process of ascertaining cost of production
and net income. In our illustration above, both marginal and absorption costing
technique had different profit figures. If we carefully check out for the difference
in the process we will find, that the difference lies in the cost of production under

COMMERCE PAPER No.6 : Accounting for Managerial Decisions

MODULE No.23: : Marginal costing and absorption costing (practical)
____________________________________________________________________________________________________

the two methods. For marginal costing cost of

production is being calculated without including fixed manufacturing cost while,
under absorption costing, fixed manufacturing cost is not included in cost of
production. Due to this inclusion of fixed manufacturing cost in cost of production
under absorption costing, there are differences in value of opening and closing
inventory as value of inventory is dependent on cost of production. As already
discussed, under marginal costing for valuation of inventory we take only variable
production cost on the other hand, under absorption costing we take all production
cost whether fixed or variable.
Now, we can evaluate the difference in profit under both the methods and relate it
to the value of inventories, which is different under both the methods.
We can make three scenarios, namely-
Scenario Production =Sales Production>Sales Production<Sales
Technique
Marginal costing Equal profit Lesser profit Higher profit
Absorption costing Equal profit Higher profit Lesser profit
Reason Value of opening and as production is higher
closing inventory is than sales so, inventories
same. are being build up and
under absorption costing,
a part of fixed
manufacturing cost is
being carried forward to
next period, which
causes decrease in the
actual cost of production
as compared to marginal
costing. So, profit is
higher under absorption
costing and vice versa
when sale is greater than
production

So, we can say that marginal costing rewards sales as it shows higher profit as
compared to absorption costing when sale is greater than production ,while
absorption costing rewards production as it shows higher profit when production
is greater than sale.

COMMERCE PAPER No.6 : Accounting for Managerial Decisions

MODULE No.23: : Marginal costing and absorption costing (practical)
____________________________________________________________________________________________________

7. Summary-

In this module, we have learned calculation of profit under marginal and

absorption costing. The main difference under both the technique is the treatment
of fixed manufacturing overheads. In case of absorption costing profit is more than
marginal costing when production is more than sales and vice-versa.

COMMERCE PAPER No.6 : Accounting for Managerial Decisions

MODULE No.23: : Marginal costing and absorption costing (practical)