Absorption and marginal costing PPT _ BEC DOMS BAGALKOT by BabasabPatil

VIEWS: 67 PAGES: 58

									Absorption and marginal costing




                                  1
               Introduction
 Before we allocate all manufacturing costs to
  products regardless of whether they are fixed
  or variable. This approach is known as
  absorption costing/full costing
 However, only variable costs are relevant to
  decision-making. This is known as marginal
  costing/variable costing


                                                  2
                Definition
 Absorption costing
 Marginal costing




                             3
           Absorption costing
 It is costing system which treats all
  manufacturing costs including both the fixed
  and variable costs as product costs




                                                 4
            Marginal costing
 It is a costing system which treats only the
  variable manufacturing costs as product costs.
  The fixed manufacturing overheads are
  regarded as period cost




                                               5
 Absorption Costing
                              Cost
     Manufacturing cost                 Non-manufacturing cost

Direct      Direct       Overheads
Materials   Labour                               Period cost

     Finished goods       Cost of goods sold    Profit and loss account

 Marginal Costing
                              Cost
    Manufacturing cost                  Non-manufacturing cost

Direct      Direct    Variable       Fixed
Materials   Labour    Overheads      overhead     Period cost

     Finished goods       Cost of goods sold    Profit and loss account
                                                                    6
Presentation of costs on income
           statement




                                  7
                 Trading and profit ans loss account
         Absorption costing            Marginal costing
                                $                                          $
Sales                           X      Sales                               X
Less: Cost of goods sold        X      Less: Variable cost of
                                                Goods sold                 X
Gross profit                    X      Product contribution margin         X

Less: Expenses                         Less: variable non- manufacturing
        Selling expenses X                   expenses
        Admin. expenses X                     Variable selling expenses    X
        Other expenses X        X             Variable admin. expenses     X
                                              Other variable expenses      X
                                       Total contribution expenses         X
Variable and fixed manufacturing
                                       Less: Expenses
                                             Fixed selling expenses        X
                                             Fixed admin. expenses         X
                                             Other fixed expenses          X
Net Profit                      X      Net Profit                      8   X
Example




          9
A company started its business in 2005. The following information
Was available for January to March 2005 for the company that produced
A single product:
                                                           $
Selling price pre unit                                     100
Direct materials per unit                                  20
Direct Labour per unit                                     10
Fixed factory overhead per month                           30000
Variable factory overhead per unit                         5
Fixed selling overheads                                    1000
Variable selling overheads per unit                        4

Budgeted activity was expected to be 1000 units each month
Production and sales for each month were as follows:
                              Jan           Feb           March
Unit sold                     1000          800           1100
Unit produced                 1000          1300          900
                                                                  10
 Required:
   Prepare absorption and marginal costing
    statements for the three months




                                              11
Absorption costing




                     12
                              January   February   March
                              $         $          $
Sales                         100000    80000      110000
Less: cost of good sold ($65) 65000     52000      71500
                                        28000      38500
Adjustment for Over-/(under)
Absorption of factory overhead          9000       (3000)
Gross profit                 35000      37000      35500
Less: Expenses
   Fixed selling overheads 1000         1000       1000
   Variable selling overheads 4000      3200       4400
Net profit                   30000      32800      30100



                                                       13
Marginal costing




                   14
                            January   February   March
                            $         $          $
Sales                       100000    80000      110000
Less: Variable cost of good
        sold ($35)            35000   28000      385500
Product contribution margin 65000     52000      71500
Less: Variable selling overhead4000   3200       4400
Total contribution margin     61000   48800      67100
Less: Fixed Expenses
   Fixed factory overhead 30000       30000      30000
   Fixed selling overheads 1000       1000       1000
Net profit                    30000   32800      30100



                                                    15
Wk1:
Standard fixed overhead rate
= Budgeted total fixed factory overheads
   Budgeted number of units produced

=   $30000
   1000 units
= $30 units
Wk 2:
Production cost per unit under absorption costing:
                                                     $
Direct materials                                     20
Direct labour                                        10
Fixed factory overhead absorbed                      30
Variable factory overheads                           5
                                                     65   16
Back
Wk 3:
(Under-)/Over-absorption of fixed factory overheads:
                           January        February    March
                           $              $           $
Fixed overhead             30000          39000       27000
Fixed overheads incurred 30000            30000       30000
                           0              9000        (3000)
                  1000*$30         1300*$30      900*$30


Wk 4:             No fixed factory overhead
Variable production cost per unit under marginal costing:
                                                       $
Direct materials                                       20
Direct labour                                          10
Variable factory overhead                              5
                                                            17
Back                                                   35
Difference between absorption
     and marginal costing




                                18
              Absorption costing   Marginal costing
Treatment for Fixed                Fixed manufacturing
fixed         manufacturing        overhead are treated
manufacturing overheads are        as period costs. It is
overheads     treated as product   believed that only the
              costing. It is       variable costs are
              believed that        relevant to decision-
              products cannot be   making.
              produced without     Fixed manufacturing
              the resources        overheads will be
              provided by fixed    incurred regardless
              manufacturing        there is production or
              overheads            not
                                                      19
                Absorption costing      Marginal costing
Value of        High value of           Lower value of
closing stock   closing stock will be   closing stock that
                obtained as some        included the variable
                factory overheads       cost only
                are included as
                product costs and
                carried forward as
                closing stock




                                                          20
         Absorption costing          Marginal costing
Reported If the production = Sales, AC profit = MC Profit
profit
          If Production > Sales, AC profit > MC profit
          As some factory overhead will be deferred as
          product costs under the absorption costing

          If Production < Sales, AC profit < MC profit
          As the previously deferred factory overhead
          will be released and charged as cost of goods
          sold
                                                          21
Argument for absorption costing




                                  22
 Compliance with the generally accepted accounting
  principles
 Importance of fixed overheads for production
 Avoidance of fictitious profit or loss
    During the period of high sales, the production is small
     than the sales, a smaller number of fixed manufacturing
     overheads are charged and a higher net profit will be
     obtained under marginal costing
    Absorption costing is better in avoiding the fluctuation of
     profit being reported in marginal costing


                                                               23
Arguments for marginal costing




                                 24
 More relevance to decision-making
 Avoidance of profit manipulation
    Marginal costing can avoid profit manipulation by
     adjusting the stock level
 Consideration given to fixed cost
    In fact, marginal costing does not ignore fixed costs in
     setting the selling price. On the contrary, it provides useful
     information for break-even analysis that indicates whether
     fixed costs can be converted with the change in sales
     volume


                                                                 25
Break-even analysis




                      26
                 Definition
 Breakeven analysis is also known as cost-
  volume profit analysis
 Breakeven analysis is the study of the
  relationship between selling prices, sales
  volumes, fixed costs, variable costs and
  profits at various levels of activity



                                               27
                Application
 Breakeven analysis can be used to determine a
  company’s breakeven point (BEP)
 Breakeven point is a level of activity at which
  the total revenue is equal to the total costs
 At this level, the company makes no profit




                                               28
   Assumption of breakeven point
             analysis
 Relevant range
   The relevant range is the range of an activity over which
    the fixed cost will remain fixed in total and the variable
    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 increasing number of
    units produced


                                                                 29
 Sales revenue
   The total revenue will increase with the increasing
    number of units produced




                                                     30
     Cost $

                           Total cost

                             Variable cost

                              Fixed cost

                               Sales (units)
Total Cost/Revenue $

                            Sales revenue
                         Profit
                                Total cost


                                                31
                   BEP          Sales (units)
Calculation method




                     32
           Calculation method
   Breakeven point
   Target profit
   Margin of safety
   Changes in components of breakeven analysis




                                              33
Breakeven point




                  34
           Calculation method
 Contribution is defined as the excess of sales
  revenue over the variable costs

 The total contribution is equal to total fixed
  cost




                                                   35
                   Formula

Breakeven point
      Fixed cost
=
   Contribution per unit

Sales revenue at breakeven point

= Breakeven point *selling price




                                   36
Alternative method:
Sales revenue at breakeven point
    Contribution required to breakeven
=
         Contribution to sales ratio Contribution per unit
                                        Selling price per unit
 Breakeven point in units
     Sales revenue at breakeven point
 =
          Selling price


                                                           37
                  Example
 Selling price per unit          $12
 Variable cost per unit          $3
 Fixed costs                     $45000
Required:
   Compute the breakeven point




                                           38
Breakeven point in units =       Fixed costs
                            Contribution per unit
                         = $45000
                             $12-$3
                         = 5000 units


Sales revenue at breakeven point = $12 * 5000 = $60000




                                                         39
            Alternative method
Contribution to sales ratio $9 /$12 *100% = 75%
Sales revenue at breakeven point
= Contribution required to break even
       Contribution to sales ratio
= $45000
   75%
= $60000
Breakeven point in units = $60000/$12 = 5000 units

                                                     40
Target profit




                41
                    Formula

No. of units at target profit
     Fixed cost + Target profit
=
      Contribution per unit
Required sales revenue
    Fixed cost + Target profit
=
    Contribution to sales ratio




                                  42
                   Example
 Selling price per unit            $12
 Variable cost per unit            $3
 Fixed costs                       $45000
 Target profit                     $18000
Required:
   Compute the sales volume required to achieve the
    target profit


                                                       43
 No. of units at target profit
      Fixed cost + Target profit
 =
       Contribution per unit
      $45000 + $18000
 =
            $12 - $3
  = 7000 units

Required to sales revenue = $12 *7000
                          = $84000




                                        44
           Alternative method

Required sales revenue
    Fixed cost + Target profit
=
    Contribution to sales ratio
   $45000 + $18000
=
        75%
= $84000

Units sold at target profit = $84000 /$12 = 7000 units


                                                         45
Margin of safety




                   46
            Margin of safety
 Margin of safety is a measure of amount by
  which the sales may decrease before a
  company suffers a loss.
 This can be expressed as a number of units or
  a percentage of sales




                                              47
                 Formula
Margin of safety
= Budget sales level – breakeven sales level

Margin of safety
= Margin of safety *100%
  Budget sales level




                                               48
                                       Sales revenue
Total Cost/Revenue $



                              Profit
                                             Total cost



                                          Sales (units)
                   BEP
                       Margin of safety


                                                          49
                 Example
 The breakeven sales level is at 5000 units.
  The company sets the target profit at $18000
  and the budget sales level at 7000 units
Required:
  Calculate the margin of safety in units and
  express it as a percentage of the budgeted
  sales revenue



                                                 50
Margin of safety
= Budget sales level – breakeven sales level
= 7000 units – 5000 units
= 2000 units

Margin of safety
= Margin of safety *100 %
  Budget sales level
= 2000 *100 %
  7000
= 28.6%
The margin of safety indicates that the actual sales can fall by
2000 units or 28.6% from the budgeted level before losses are
incurred.
                                                             51
Changes in components of
    breakeven point




                           52
                    Example
   Selling price per unit    $12
   Variable price per unit   $3
   Fixed costs               $45000
   Current profit            $18000




                                       53
 If the selling prices is raised from $12 to $13,
  the minimum volume of sales required to
  maintain the current profit will be:

          Fixed cost + Target profit
          Contribution to sales ratio
           $45000 + $18000
      =
              $13 - $3
      = 6300 units
                                                 54
 If the fixed cost fall by $5000 but the variable
  costs rise to $4 per unit, the minimum volume
  of sales required to maintain the current profit
  will be:

        Fixed cost + Target profit
       Contribution to sales ratio
      = $40000 + $18000
          $12 - $4
      = 7250 units
                                                 55
Limitation of breakeven point




                                56
 Limitations of breakeven analysis
 Breakeven analysis assumes that fixed cost,
  variable costs and sales revenue behave in
  linear manner. However, some overhead costs
  may be stepped in nature. The straight sales
  revenue line and total cost line tent to curve
  beyond certain level of production



                                               57
 It is assumed that all production is sold. The
  breakeven chart does not take the changes in
  stock level into account
 Breakeven analysis can provide information
  for small and relatively simple companies that
  produce same product. It is not useful for the
  companies producing multiple products


                                               58

								
To top