Question

has no 4.80 2.00 1.20 1200 units 198azn QUESTION 1 At the start of period one Tommy opening inventories. Tommy sells his product for £12 per mit incurring the following uit Variable Direct materials Direct labour Variable Production overheads Fized production overheads are £3,000 fized selling overheads are £1,000, and production and sales are as follows: Pd1 Pd 2 Sales 1800 units Production 1400 units 1600 units Overhead absorption rates are calculated based on budgeted production of 1500 units. Required: a) Prepare profit statements using marginal Casting b) Prepare profit statements using absorption Casting c) Explains why the profit figures differ using different methods. d) Explain why the adjustment is necessary for under and over absorption of overheads in the absorption Costing model. b)

Answer 1

Solution a)Income statement of Tominy (Marginal Costing) Year 1 Amount(s) Amount($) 14,400.00 Amount(s) Year 2 Amount(s) Sales Revenue 21,600.00 Cost Goods Sold Opening Inventory Marginal rate of 8) Add: Prodcution Cost (@Marginal rate of 8) Less: Closing Inventory (@Marginal rate of 8) 1,600.00 12.800.00 11,2x2.00) 1,600.00 9,600.00 4,800.00 14,400.00 7,200.00 4,800.00 7,200.00 Less: Variable Selling & Administrative Expenses Contribution Less: Fixed Overhead Production Overhead Selling & Administrative Overhead Net profit 3,(XX.CO 1,0XX0.00 3,000.00 1,000.00 4,000.00 800.00 4,000.00 3,200.00 b) Income statement of Tommy(Absorption Costing) Year 1 Amount(s) Amount() 14,400.00 Amount(s) Year 2 Amount() Sales Revenue 21,600.00 14,000.00 2.000,00 2,000.00 16,000.00 Cost of Goods Sold Opening Inventory (@absorption rate of 10) Add: Prodcution Cost (@absorption rate of 10) Less: Closing Inventory (@absorption rate of 10) Gross profit @ Nonnai Over/Under) Abosrption Gross profit @ Actual Less: Selling & Administrative Overhead Variable Fixed Net profit 12,000.00 2,400.00 (2,200.00) 200.00 18,000.00 3,600.00 2.200,00 5,800.00 1,000.00 1,000.00 1,000.00 (800.00) 1,000.00 4,800.00 Calculation of Absorption Rale per unit 4.80+2.00+1.20+3000/1500 10.0X) ** Actual Overhead Inccurred Over/(Under) Absorption 14,200.00 (2,200,00) 15,800.00 2,200.00 Reason for difference in profits under methods Under marginal cosling inventory of finished goods as well as work in progress is valued at variable costs only. On the contrary, absorption costing values stocks of inventory of finished goods and work in progress at both variable costs and an absorbed amount for fixed production overheads. In the case of Tommy under marginal cosling, only variable costs are included the ending inventory figure. To reconcile the profit under absorption costing and marginal costing, we may either subtract the fixed overhead induded in ending inventory from the absorption cost operating profit to arrive at the marginal cost operating profit or add the fixed overhead costs in ending inventory to the marginal cost operating profit to arrive at the absorption cost operating profit. d) Absorbed overhead is manufacturing, overhead that has been applied to products or other cost objects. Overhead is usually applied based on a predetermined overhead allocation rate. Overhead is overabsorbed when the amount allocated to a product or other cost object is higher than the actual amount of overhead, while the amount is underabsorbed when the amount allocated is lower than the actual amount (overhead.Since absorption costing requires the allocation of what may be a considerable amount of overhead costs to products, a large proportion of a product's costs may not be directly traceable to the product. Direct costing or constraint analysis do not require the allocation of overhead to a product, and so may be more useful than absorption costing for incremental pricing decisions where you are more concerned with only the costs required to build the next incremental unit of product. It is also possible that an entity could generate extra profits simply by manufacturing more products that it does not sell. This situation arises because absorption costing requires fixed manufacturing overhead to be allocated to the total number of units produced - if some of those units are not subsequently sold, then the fixed overhcad costs assigned to the excess units are never charged to expense, thereby resulting in increased profils. A manager could falsely authorize excess production lo create these extra profils, but it burdens the entity with potentially obsolete inventory, and also requires the investment of working capital in the extra