STAR FINANCIAL CONSULTANTS CPA REVIEW CLASSSES
MARGINAL AND ABSORPTION COSTING
Income statement may be prepared by two methods:
 Marginal Costing Method
 Absorption Costing Method
 MARGINAL COSTING PRINCIPLES
Under this method or principle Inventory cost is determined as a sum or total of variable production costs.
The variable non-production costs such as (selling costs and commission) plus fixed production and nonproduction are not included in valuation and thus deducted as periodic costs.
- Total variable production cost per unit is calculated as follows:
Direct material cost per unit
XXX
Add: Direct labour cost per unit
XXX
Add: Variable production overhead
XXX
TVPCU
XXX
INCOME STATEMENT BY USING MARGINAL COSTING PRINCIPLES (FORMAT)
Sales Revenue (Units sold× SPU)
XXX
Less: Cost of Goods Sold:
Opening Stock (Units ×TVPCU)
XXX
Add: Production Cost (Units produced × TVPCU)
XXX
Less: Closing Stock (Units ×TVPCU)
(XXX)
(XXX)
Gross Profit
XXX
Less: Variable Non Production Costs:
Selling Cost
(XXX)
Commission
(XXX)
XXX
Less: Fixed Costs:
Production Cost (Budgeted Units ×FOAR)
(XXX)
Non-Production Cost (marketing and administration cost )
(XXX)
NET PROFIT
XXX
Note: FOAR = Budgeted Fixed Production Cost
Budgeted / Normal Production (Units)
 ABSORPTION COSTING PRINCIPLES
Under this method or principle, the cost of inventory is determined as a sum or total of all production costs
(both variable and fixed costs). The variable and fixed non-production costs are deducted or treated as
periodic costs - The total production cost is calculated as follows:
Direct material cost per unit
XXX
Add: Direct labour cost per unit
XXX
Add: Variable production overhead
XXX
Fixed production cost
XXX
Total production cost per unit (TPCU)
XXX
STAR FINANCIAL CONSULTANTS CPA REVIEW CLASSSES
INCOME STATEMENT BY USING ABSORPTION COSTING PRINCIPLES (FORMAT)
Sales Revenue (Units sold× SPU)
XXX
Less: Cost of Goods Sold:
Opening Stock (Units ×TPCU)
XXX
Add: Production Cost (Units produced × TPCU)
XXX
Less: Closing Stock (Units ×TPCU)
(XXX)
(XXX)
Gross Profit
XXX
Under / Over absorption
XXX / (XXX)
XXX
Less: Variable Non Production Costs:
Selling Cost
(XXX)
Commission
(XXX)
XXX
Less: Fixed non production Costs:
(marketing and administration cost )
(XXX)
NET PROFIT
XXX
 HOW TO DETERMINE / CALCULATE THE OVER OR UNDER ABSORPTION
Compare: Budgeted production FOH (Budgeted Production Units × FOAR)
Actual production FOH (Actual Units Produced × FOAR)
Over / Under Absorption


XXX
XXX
XXX
When budgeted production FOH is more than actual production FOH = Over absorption
When budgeted production FOH is less than actual production FOH = Under absorption
 Reconciliation of the Net Profit (By Marginal Costing) and Net Profit (By Absorption Costing)
CHANGE in PROFIT
=
CHANGE in STOCK × FOAR
(Absorption Profit – Marginal Profit)
=
(Closing Stock – Opening Stock) × FOAR
 Reconciliation of Absorption Profits for Different Periods
Absorption Profit 2 – Absorption Profit 1 = (Change in Production) × FOAR + (Change in Sales) × unit profit
STAR FINANCIAL CONSULTANTS CPA REVIEW CLASSSES
PRACTICE QUESTIONS ON MARGINAL & ABSORPTION COSTIONG
QUESTION 1
Laik Company produces a single product which is bottled and sold in cases. Data for the last financial year
were as follows.
Production
40,000 cases
Sales
32,000 cases
Selling price per case
TZS 600
Costs:
Production costs per case:
 Direct materials:
TZS140
 Direct labour:
TZS120
 Variable overhead
TZS80
 Fixed overhead (budgeted & incurred)
TZS 2,160,000
Selling and administration costs:
Fixed
TZS500,000
Variable
15% of sales revenue
There were no opening stock of finished goods and he work in process stock may be assumed to be the
same at the end of the year as it was at the beginning of the year.
Required:
(a) From above information given, prepare income statements for the year under:
(i) Absorption costing method
(ii) Marginal costing method.
(b) Prepare a statement to reconcile the net income or loss obtained under (i) above.
QUESTION 2
Tumbi motors limited assembles and sells motor vehicles. It uses an actual costing system, in which unit
costs are calculated on a monthly basis. Data relating to the months of March. 2004 is as given below.
Particulars
Opening inventory
150 Units
Production
400 Units
Sales
520 Units
Selling price per motor vehicle
TZS 24,000
Variable cost data:
Manufacturing costs per unit produced
TZS10,000
Distribution costs per unit sold
TZS 3,000
Fixed cost data
Manufacturing costs
TZS 2,000,000
Marketing costs
TZS 600,000
Required
(a) Prepare an income statement for Tumbi Limited under
(i) Variable costing and
(ii) Absorption costing
(b) Clearly reconcile the differences between a (i) and (ii) above for the month march
STAR FINANCIAL CONSULTANTS CPA REVIEW CLASSSES
QUESTION 3
A company sells a single product at a price of TZS. 14 per unit. Variable manufacturing costs per units of the
product are TZS6.4. Fixed manufacturing overheads absorbed into the cost of production at a unit rate (based
on the normal activity of 20,000 units per period) are TZS92,000 per period. Any over or under absorbed
fixed manufacturing overhead balances are transferred to the profit or loss account at the end of each period,
in order to establish the manufacturing profit. Sales and production (in units) for the months of March and
April 2011 were as follows
March
April
Sales
15,000
22,000
Production
18,000
21,000
Manufacturing profit in March 2011 was reported TZS 35,800
Required:
(a) Prepare absorption costing profit statement for April 2011
(b) Prepare marginal costing profit statement for April 2011
(c) Explain, with supporting calculations the reasons for change in profits between March and April
where absorption costing is used in each period and reconcile the difference.
QUESTION 4
The following data has been extracted from the budget and the standard costing profit statement of Abacus
ltd. A company which manufactures and sells a single product.
TZS (per unit)
Selling price
45,000
Direct material cost
10,000
Direct Wages cost
4,000
Variable production overhand cost
2,500
Budget selling and distribution costs are follows:
Variable cost per unit
TZS 1,500
Fixed
TZS 80,000,000 per annum
Budgeted administration costs are
TZS 120,000,000 per annum
Fixed production overhead costs are budgeted at TZS 400,000,000 per annum. Budgeted normal production
is 320,000 units per annum.
The following Patten of sales and production is expected during the first six months of year 2010.
1st Quarter January – march
2nd Quarter April – June
Sales in units
60,000
90,000
Production in units
70,000
100,000
There is no stock on 1st January 2010
Required:
(a) Prepare profit statements for each of the two quarters using.
(i) Marginal costing
(ii) Absorption costing
(b) Reconcile the profits for each of the quarters in (a) above
STAR FINANCIAL CONSULTANTS CPA REVIEW CLASSSES
QUESTION 5
Keypuzzle limited manufactures a novelty keyring which it sells to conference and event organisers. The
keyring comprises a basic metal ring to attach keys and a wooden puzzle which was invented by the
managing director and founder of the company, Paul Crean. Having successfully developed and patented
the prototype of the keyring, the company commenced production in ennis five years ago. The manufacturing
facility has a maximum production capacity of 500,000 keyrings, which is well in excess of current sales. The
production director has advised Paul that “it doesn’t make sense not to use the available capacity to produce
more keyrings as they will be sold over the coming years”. Consequently, over the past four years the
company has produced more key rings than it has sold and has built up a substantial inventory. For its
management accounts the company uses variable (marginal) costing and Paul has raised concerns with the
management accountant regarding the declining profit levels. It was agreed that the management accountant
would prepare the management accounts for the current year and prior year using absorption costing,
highlighting the differences compared to variable costing. Unfortunately, the management accountant is ill
and has not completed the absorption and variable cost comparison. Information that had been compiled
relating to the comparison is shown below.
31 March 2016
31 March 2015
Budgeted annual fixed production overhead
TZS105,625
TZS105,625
Sales (units)
350,000
319,500
Opening inventory (units)
19,500
18,000
Closing inventory (units)
22,000
19,500
Direct material (per unit):
- Steel ring @
TZS 0.08
- Varnished beech @
TZS 0.12
Direct labour
:
4 mins per unit @ TZS 9 per hour
Variable overhead :
10% of direct labour cost
The Keyring sells for TZS1.95. Direct material and direct labour costs have not increased over the two year
period. Fixed production overheads are absorbed based on units of production assuming that the company
is operating at 65% of its maximum capacity. The company’s actual annual fixed production overhead is
equal to the budgeted amount.
Required
(a) Show the product cost for one keyring under variable (marginal) costing and absorption costing
(b) Prepare management accounts for the year ending 31 March 2016 and 2015 showing profit
calculated using:
(i) Variable (marginal) costing
(ii) Absorption costing
(c) Reconcile the profit calculated at (b) (i) and (ii) above.
(d) From the perspective of Keypuzzle limited, outline TWO benefits and TWO limitations of using
absorption costing.
STAR FINANCIAL CONSULTANTS CPA REVIEW CLASSSES
QUESTION 6
Dubh DAC is based in Tanzania and manufactures one product, a storage unit made from recycled plastic
which sells for TZS58 per unit. Production and sales data for each of the first three months of 2019 are as
follows:
January
February
March
Sales in units (actual)
4,800
5,000
7,600
Production in units (actual)
5,400
4,800
8,000
 Budgeted cost information for each month
Product cost:
 Direct materials: 2 square metres @ TZS4.20 per square metre.
 Direct labour: 2 hours @ TZS10.25 per hour.
 Variable production overheads: 50% of direct labour.

Actual cost information for each month
 Fixed production overheads: TZS12,000.
 Fixed selling overheads: TZS22,500.
 Sales commission: 10% of sales value.
There was no opening inventory at 1 January 2019. Fixed production overheads are budgeted at TZS120,000
per annum and are absorbed into products based on budgeted normal output of 60,000 units per annum.
REQUIREMENT:
(a) Prepare a profit statement for each of the three months using absorption costing principles. (6 marks)
(b) Prepare a profit statement for each of the three months using variable (marginal) costing principles.
(8 marks)
(c) Present a reconciliation of the profit or loss figures given in your answer to (a) and (b) together with an
explanation of the reason for the difference.
(3 marks)
(d) The managing director of Dubh DAC wants to use variable (marginal) costing principles as the basis for
both management accounts and the company’s financial statements. Outline TWO reasons against this
course of action.
(3 marks)
[Total: 20 Marks]