MANAGEMENT ACCOUNTING.

TOPIC: MARGINAL AND

ABSORPTION COSTING & CVP ANALYSIS

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 MARGINAL AND M & A COSTING
ABSORPTION COSTING

MARGINAL AND ABSORPTION COSTING

 If inventory values are different, then this will have an
 Marginal costing is an accounting system in which effect on profits reported in the income statement in a
variable costs are charged to cost units and fixed costs period. Profits determined using marginal costing
for the period are written off in full to the income principles will therefore be different to those using
statement. absorption costing principles.

• The marginal cost of a unit of product is the total of

the variable costs of the product (i.e. direct materials,
direct labour and variable overheads).

• The contribution concept lies at the heart of marginal

costing. Contribution can be calculated as follows.

Contribution = Sales – Variable costs

 Absorption costing is a costing technique in which full

cost or total cost (VC and FC of production) are charged to
cost units and non production cost are written off.

NOTE:
 Marginal costing values inventory at the total variable
production cost of a unit of product.

 Absorption costing values inventory at the full production

cost of a unit of product.

 Inventory values will therefore be different at the

beginning and end of a period under marginal and
absorption costing
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 MARGINAL AND M & A COSTING
ABSORPTION COSTING

MARGINAL AND ABSORPTION COSTING

January-March
MAJOR DISADVANTAGES Sales 240,000
 The main disadvantages of marginal costing are that Production 280,000
closing inventory is not valued in accordance with IAS 2 There were no opening inventory at the beginning of January.
principles and that fixed production overheads are not a. Prepare income statement for the quarter, using
‘shared’ out between units of production, but written off
i. Marginal costing
in full instead.
ii. Absorption costing
b. Prepare statement of reconciliation
 The main disadvantages of absorption costing are that
it is more complex to operate than marginal costing and Example 2
it does not provide any useful information for decision
Using the information below, prepare profit statements for June and
making (like marginal costing does).
July using: (a) marginal costing, (b) absorption costing.
A company produces and sells one product only which sells for £50
Example 1 per unit. There was no inventory at the end of May and other
Amara Construction Limited manufactures a single product, information is as follows.
GALA, details of which are as follows: Standard cost per unit £
Per Unit GH¢ Direct material 18
Selling Price 180.00 Direct wages 4
Direct Material 40.00 Variable production overhead 3

Direct Labour 16.00

Budgeted and actual costs per month
Variable overheads 10.00
Fixed production overhead 99,000
Annual fixed production overheads are budgeted to be GH¢1.6 Fixed selling expenses 14,000
million and Amara Ltd expects to produce 1,280,000 units of
Fixed administration expenses 26,000
GALA each year. Overheads are absorbed on a per unit basis.
Variable selling expenses 10% of sales value
Actual overheads are 1.6 million for the year.
Normal capacity is 11,000 units per month.
Budgeted fixed selling costs are GH¢320,000 per quarter.
The number of units produced and sold was:
Actual sales and production units for the first quarter are given
June (units) July (units)
below.
Sales 12,800 11,000
Production 14,000 10,200
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 MARGINAL AND M & A COSTING
ABSORPTION COSTING

MARGINAL AND ABSORPTION COSTING

Example 4
Example 3 Sabbat Ltd manufactures beds for students in a private hostel.
BBQ Co. Ltd. is a manufacturer of glass bottles which has been The following information relates to the activities of the
affected by competition from plastic bottles and currently company from January to June 2010:
operating below capacity. The data below relate to BBQ Co. Ltd. GHC
which makes and sells one product (glass bottles):
Selling price per unit of product 2,000
January February March
Variable cost per unit of product 800
(Units) (Units) (Units)
Fixed manufacturing cost 1 month 300,000
Sales 5,000 7,000 4,000
Non-manufacturing cost 1 month 100,000
Production 9,000 3,000 4,000
There were no opening stocks in January.
GH¢ GH¢ GH¢
Normal production level in Sabbat Ltd is expected to be 1,500
Selling price per Unit 100 100 100 beds per month, and production and sales for the period to June
Variable production cost per Unit 60 60 60 2010 are presented below;
Fixed production overhead incurred 120,000 120,000 120,000 Jan. Feb. Mar. April May June
Units sold 1,500 1,200 1,800 1,500 1,500 1,600
Fixed production overhead cost per unit, Units produced 1,500 1,500 1,500 1,500 1,700 1,400
being the predetermined overhead Required:
absorption rate 15 15 15 (a) Prepare an Income Statement for Sabbat Ltd for each month
Selling & Distribution cost (fixed) 50,000 50,000 50,000 based on the:
(i) Marginal Costing System
Required: (ii) Absorption Costing System
(a) Prepare comparative profit statements for each month using: (b) Explain the difference in profit of the two methods
(i) Absorption costing
(ii) Marginal costing

(b) Explain two justifications each for using both variable and
absorption costing.

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 MARGINAL AND M & A COSTING
ABSORPTION COSTING

MARGINAL AND ABSORPTION COSTING

Example 4
Example 3 Sabbat Ltd manufactures beds for students in a private hostel.
Oboshie Ltd produces a single product, Tort Bitters. The data The following information relates to the activities of the
for cost per unit and selling price of the product are as follows: company from January to June 2010:
Tort Bitters (GHC) GHC
Direct materials 30 Selling price per unit of product 2,000
Direct labour 30 Variable cost per unit of product 800
Variable manufacturing overhead 20
Fixed manufacturing cost 1 month 300,000
Fixed manufacturing overhead 120
Non-manufacturing cost 1 month 100,000
Factory cost 200
There were no opening stocks in January.
Profit mark up (50%) 100
Normal production level in Sabbat Ltd is expected to be 1,500
Selling price 300 beds per month, and production and sales for the period to June
These figures were used for the calculation of finished goods 2010 are presented below;
stocks. Oboshie prepares Income Statement for the first and Jan. Feb. Mar. April May June
second half of the year separately as follows: Units sold 1,500 1,200 1,800 1,500 1,500 1,600
Jan to June July to Dec Units produced 1,500 1,500 1,500 1,500 1,700 1,400
GHC GHC Required:
Sales 3,000,000 3,750,000
(a) Prepare an Income Statement for Sabbat Ltd for each month
Cost: Direct materials 390,000 225,000 based on the:
Direct labour 390,000 225,000 (i) Marginal Costing System
Variable manufacturing overhead 260,000 150,000 (ii) Absorption Costing System
Fixed manufacturing overhead 1,320,000 1,320,000 (b) Explain the difference in profit of the two methods
Factory cost of production 2,360,000 1,920,000
Add operating stock 600,000 1,200,000

BBQ Co.

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 CVP ANALYSIS CVP ANALYSIS
 Cost–volume–profit (CVP )analysis is defined in CIMA’s 3. It is assumed that activity is the only factor affecting costs,
Official Terminology as ‘the study of the effects on future and factors such as inflation are ignored. This is one of the
profit of changes in fixed cost, variable cost, sales price, reasons why the analysis is limited to being essentially a
quantity and mix’. short-term decision aid.
• A more common term used for this type of analysis is 4. Apart from the unrealistic situation of a constant product
breakeven analysis. mix, the charts can only be applied to a single product or
service.
• If we know how much contribution is earned from each unit
sold, then we can calculate the number of units required to  THE CONCEPT OF CONTRIBUTION AND BREAK-

CVP ANALYSIS
break even as follows: EVEN CALCULATION

ASSUMPTIONS UNDERLYING CVP ANALYSIS • Contribution is so called because it literally does contribute
1. The selling price is assumed to be constant towards fixed costs and profit.
2. Cost can be divided into two; thus, Fixed Cost and Variable
Cost • As sales revenues grow from zero, the contribution also
3. volume drive cost grows until it just covers the fixed costs. This is the
4. Fixed cost is constant, variable cost is not constant but breakeven point where neither profits nor losses are made.
variable cost per unit is not constant
5. Single product is assumed to be produced throughout the • It follows that to break even, the amount of contribution
period but where multiple products are produced a constant must exactly match the amount of fixed costs.
production/sales mix is maintained throughout.
6. All units produced are sold
7. Technology is constant
 margin of safety
The limitations of breakeven(or CVP) analysis The margin of safety is the difference between the expected
1. Costs are assumed to behave in a linear fashion. level of sales and the breakeven point. The larger the margin of
safety, the more likely it is that a profit will be made, i.e. if
2. Sales revenues are assumed to be constant for each unit sold.
sales start to fall there is more leeway before the organization
begins to incur losses.
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 CVP ANALYSIS CVP ANALYSIS
C/S ratio The fixed-overhead absorption rate is based on the normal
The C/S ratio of a product is the proportion of the selling capacity of 2,000 units per month. Assume that the same
price that contributes to fixed overheads and profits. It is amount is spent each month on fixed overheads.
comparable to the gross profit margin. Budgeted sales for next month are 2,200 units.
You are required to calculate:
Example 1 (i) the breakeven point, in sales units per month;
Selling price £50 per unit (ii) the margin of safety for next month;
Variable cost £30 per unit
(iii) the budgeted profit for next month;
Fixed costs £20,000 per month

CVP ANALYSIS
(iv) the sales required to achieve a profit of £96,000 in a
Forecast sales 1,700 units per month month.
Required:
(a) Calculate Break Even units and sales Breakeven point for multiple products
(b) Margin of safety The breakeven point for a standard sales mix of products is
(c) The number of units to sell if the firm wants to achieve a calculated by dividing the total fixed costs by the weighted
profit of £10,000 per month average contribution per unit, or by the weighted average C/S
ratio.
Example 2
A company manufactures and sells a single product that has the Example 3
following cost and selling PL produces and sells two products, M and N. Product M sells
price structure: for $7 per unit and has a total variable cost of $2.94 per unit,
£/unit £/unit while Product N sells for $15 per unit and has a total variable
cost of $4.40 per unit. The marketing department has estimated
Selling price 120
that for every five units of M sold, one unit of N will be sold.
Direct material 22 The organization's fixed costs per period total $123,600.
Direct labour 36 Required
Variable overhead 14 Calculate the breakeven point for PL.
Fixed overhead 12
(84)
Profi t per unit 36
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 CVP ANALYSIS CVP ANALYSIS
Example 4 Example 6
Alpha manufactures and sells three products, the Beta, the The market price of both fowls and guinea fowls have dropped
Gamma and the Delta. Relevant information is as follows. as a result of low demand to GH₵15 and GH₵10 respectively.
Beta Gamma Delta AB Farms located at Kasoa produces 60% of fowls and 40% of
$ per unit $ per unit $ per unit guinea fowls on her farms incurring GH₵9 and GH₵8 as
variable cost per bird respectively.
Selling price 135.00 165.00 220.00
The following fixed costs are incurred annually:
Variable cost 72.80 57.90 146.20 GH₵
Total fixed costs are $1,025,000. Staff Cost 48,000

CVP ANALYSIS
An analysis of past trading patterns indicates that the products Rent 12,000
Beta, Gamma and Delta are sold in the ratio 3:4:5 respectively. Electricity 6,000
Required Depreciation 8,000
a. Alpha's breakeven point in terms of revenue of the three Other Overheads 2,000
products Required:
b. The C/S ratio (i) Calculate the number of fowls and guinea fowls to be
produced to break-even.
Example 5 (ii) If the profit target is GH₵25,000, how many birds should be
produced to meet this target?
BA produces and sells two products. The W sells for $8 per unit
and has a total variable cost of $3.80 per unit, while the R sells
for $14 per unit and has a total variable cost of $4.30. For every Example 7
five units of W sold, six units of R are sold. BA's expected fixed A company makes and sells a single product. The selling price
costs are $83,160 for the per period. Budgeted sales revenue for is $12 per unit. The variable cost of making and selling the
product is $9 per unit and fixed costs per month are $240,000.
next period is $150,040, in the standard sales mix.
The company budgets to sell 90,000 units of the product a
Required month.
Calculate the margin of safety in terms of sales revenue and also Required
as a percentage of budgeted sales revenue. (a) What is the budgeted profit per month and what is the
breakeven point in sales?
(b) What is the margin of safety?
(c) What must sales be to achieve a monthly profit of $120,000?

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 CVP ANALYSIS CVP ANALYSIS
Example 8
 Breakeven and contribution charts
ATM Ltd specializes in the production of tables. The following
is the company’s estimated profit statement for next year,
prepared using marginal costing principles.
GH¢ GH¢
Sales 220,000
Less variable costs:
Materials 51,000
Labour 70,000 121,000
Contribution 99,000

CVP ANALYSIS
Less fixed costs:
Administration 20,000
Others 25,000 45,000
Profit 54,000
Two suggestions have been made in an attempt to improve profit
next year.
1. Chief Executive’s Suggestion: I think cheaper materials could
be used, which will reduce the total material cost to GH¢40,000.
However, this will mean additional fixed costs of GH¢12,000 to
cover inspection of the cheaper materials.

2. Marketing Director’s Suggestion: He suggested that an

intensive advertising campaign can increase sales volume by
20% over the estimated amount above. Variable cost as a
percentage of revenue will be unaffected by this option, but extra
fixed costs of GH¢22,500 will be incurred in order to cover the
advertising campaign.

Requirements:
(a) For each of the original estimates, the Chief Executive’s
suggestion and the Marketing Director’s suggestion, Calculate:
(i) The company’s breakeven points
(ii) The margin of safety as a percentage.
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