Pre-Mock Exam 2012-2013
(Absorption and marginal Costing)
4. The following are the cost data relating to December 2010 and the management of Free Company wants to know
more about the company’s cost in a more organized way.
Total material cost
Total labour cost
Royalties
Indirect labour
Direct materials
Indirect expenses
Manufacturing overheads
$
90,000
71,500
23,500
38,000
55,000
16,500
56,000
REQUIRED:
(a)
Prepare a statement showing prime cost, total production cost and total cost from the above data. (3 marks)
The following are the budgeted information for January 2011:
Direct material cost
Selling price
Direct labour cost
Variable production overheads
Sales commission
Fixed production overheads: $13,500 per month
$ per unit
6
22
4
3
2
The fixed production overheads are absorbed on the budgeted activity level. Budgeted production and sales were
5,400 units. There was no opening stock on 1 January 2011. Actual production and sales volume in January 2011
were 4,500 units and 4,000 units respectively. The selling price and variable costs were the same as the budgeted
whereas the actual fixed production overheads were $15,120.
REQUIRED:
(b)
Prepare income statements for the month ended 31 January 2011 using
(1)
marginal costing and
(2)
absorption costing.
(7 marks)
(Total: 8 marks)
(a)
Statement showing prime cost, total production cost and total cost
Direct materials
Direct labour (71,500  38,000)
Royalties
Prime cost
Manufacturing overheads
Total production cost
Other overheads (90,000 – 55,000) + 38,000 – 56,000 + 16,500)
Total cost
$
55,000
33,500
23,500
112,000
56,000
168,000
33,500
201,500
(b) (1)
Free Company
Income statement for the month ended 31 January 2011
$
Sales ($22 x 4,000)
Less: Variable cost of goods sold
Direct material cost ($6 x 4,500)
Direct labour cost ($4 x 4,500)
Variable production overheads ($3 x 4,500)
Less: Closing inventory [58,500 / 4,500) x 500]
Product contribution margin
Less: Variable costs: Sales commission ($2 x 4,000)
Contribution
Less: Fixed production overheads
Net profit
27,000
18,000
13,500
(6,500)
$
88,000
52,000
36,000
(8,000)
28,000
(15,120)
12,880
(b) (2)
Free Company
Income statement for the month ended 31 January 2011
$
Sales ($22 x 4,000)
Less: Cost of goods sold
Direct material cost ($6 x 4,500)
Direct labour cost ($4 x 4,500)
Variable production overheads ($3 x 4,500)
Fixed production overheads [(13,500 / 5,400) x 4,500]
Less: Closing inventory [(69,750 / 4,500) x 500]
Gross profit
Less: Under-absorption of fixed production overheads (15,120 – 11,250)
Sales commission ($2 x 4,000)
Net profit
27,000
18,000
13,500
11,250
(7,750)
$
88,000
62,000
26,000
(3,870)
(8,000)
14,130
HKDSE
(2012, 4)
(Absorption and marginal Costing)
Magic Company manufactures and sells a single product, Product X. For the purpose of preparing the budget for
Product X for the month of November 2012, the following information is provided:
(i)
The budgeted production and budgeted sales for the month are 5000 and 4400 units respectively.
(ii) The expected selling price is $300 per unit.
(iii) The direct material cost of the production is $40 per unit. An additional transportation cost of $2 per unit is to be
incurred for the purchase of the direct materials.
(iv) Each unit of product requires 2 hours of direct labour. The hourly rate of direct labour is $60.5.
(v) The production overheads of the product comprise a fixed and a variable element. It is the company’s policy to
apportion variable production overheads in relation to the number of units produced.
Assuming the monthly fixed production overheads of the company remain the same in 2012, the annual budgeted
production overheads will be $1 159 000 if 58 000 units are produced each year, and $1 203 000 if 66 000 units
are produced each year.
(vi) Selling and distribution expenses consist of a sales commission of $8 per unit sold and a fixed monthly distribution
expense of $50 000.
REQUIRED:
Magic Company adopts the marginal costing system. Assume it does not keep any inventories as at 31 October 2012,
calculate the following for Product X for the month ended 30 November 2012:
(a) the budgeted total value of closing inventories
(b) the budgeted total amount of contribution
(c) the budgeted total amount of net profit
(a)
Budgeted total value of closing inventories
Direct materials cost per unit
Transportation cost on direct materials per unit
Direct labour cost per unit ($60.5 x 2)
Variable production overheads per unit [($1 203 000  $1 159 000) / (66 000 – 58 000)]
Total variable cost per unit
Unit of closing inventories (5 000 – 4 400)
(b)
Budgeted total amount of contribution
Sales price per unit
Less Total variable cost per unit
Sales commissions per unit
Contribution per unit
Number of unit sold
(c)
Budgeted total amount of net profit
Total amount of contribution
Less Fixed production overhead ($1 159 000  $5.5 x 58 000)/12
Fixed monthly distribution expense
$
40.0
2.0
121.0
5.5
168.5
600
101 100
$
300
168.5
8
123.5
4 400
543 400
$
543 400
70 000
50 000
423 400
(HKALE 2007, Paper 2, 2)
(Cost classification, Absorption and marginal Costing)
Starry Ltd had the following information for preparing the 2007 master budget for Product X.
Selling price
Direct material
Direct labour
$160 per unit
0.5 kg per unit at $48 per kg
5 hours per unit at $15 per hour
In the production process, only the following three types of factory overheads are incurred, each of which demonstrating a
different cost behavior. The maximum production capacity was 30,000 units. Information relating to factory overheads at different
levels of production was shown as follows:
Level of production (units)
Factory overheads – Type 1
Type 2
Type 3
15,000
$
180,000
240,000
355,000
775,000
18,000
$
180,000
240,000
400,000
820,000
21,000
$
(i)
240,000
445,000
?
24,000
$
180,000
300,000
(iii)
?
27,000
$
180,000
(ii)
535,000
?
30,000
$
180,000
300,000
580,000
1,060,000
You are required to:
(a) Find the missing figures (i) and (iii) in the table above.
(b) Based on your answer to (a), identify and describe the cost behavior for each of the three types of factory overheads.
(c) Calculate the contribution per unit of Product X and the total budgeted gross profit for year 2007 at the level of maximum
capacity.
(a) (i)
$180,000
(ii)
$300,000
(iii)
$490,000
Variable cost per unit = ($580,000 – $535,000) / (30,000 – 27,000) = $15
Fixed cost element (15,000 level) = $355,000 – 15,000 x $15 = $130,000
Total cost (24,000 level) = $130,000 + 24,000 x $15 = $490,000
(b)
Type 1 is fixed cost which does not change regardless of the level of production
Type 2 is semi-fixed cost which does not change within a range of activity
Type 3 is semi-variable cost. It consists of fixed and variable elements. The variable cost changes in direct
proportion with the level of production.
(c) Contribution per unit of Product X
$
Selling price
Variable costs
Direct material (0.5 x $48)
Direct labour (5 x $15)
Factory overheads (from (a)(iii))
Contribution per unit
24
75
15
$
160
114
46
Total budgeted gross profit
Total contribution (30,000 x $46)
Fixed factory overhead ($180,000 + $300,000 + $130,000)
Budgeted gross profit
$
1,380,000
610,000
770,000
HKDSE Sample 2 (Paper 2A, 2)
(Absorption and marginal Costing)
Perry Ltd started producing Product A on 1 January 2012. The unit selling price and cost of Product A for the month of
January 2012 were as follows:
Selling price
Direct material
Direct labour
Variable production overheads
Variable selling and administrative expenses
(i)
($/unit)
5.90
1.20
1.40
0.70
0.15
Fixed production overheads were budgeted at $308,000 per month and were absorbed based on the number of
units produced. Actual fixed production overheads of Product A were the same as the absorbed fixed production
overheads for the month.
(ii) Budgeted production and budgeted sales were the same at 280,000 units per month.
(iii) Actual production and actual sales of Product A for the month were 250,000 units and 220,000 units respectively.
(iv) Actual fixed selling and administrative expenses were $110,000.
(v) There were no closing direct materials and work-in-progress inventories of Product A as at 31 January 2012.
REQUIRED:
(a) Prepare the income statement for the month ended 31 January 2012 using absorption costing.
(b) As compared with the absorption costing system, advise Perry Ltd two advantages of using the marginal costing
system.
(a)
Perry Ltd
Income Statement for the year ended 31 January 2012 using absorption costing
$
Sales (220,000  $5.90)
Less: Cost of goods sold:
Direct materials (250,000 × $1.20)
300,000
Direct labour (250,000 × $1.40)
350,000
Variable production overheads (250,000 × $0.70)
175,000
Fixed production overheads absorbed (250,000 × $1.1)
275,000
1,100,000
Less: Closing inventory [(250,000  220,000) x $4.4]
132,000
Gross profit
Less: Variable selling and administrative expenses (220,000 x $0.15)
33,000
Fixed selling and administrative expenses
110,000
Net profit
$
1,298,000
968,000
330,000
143,000
187,000
Unit fixed production overheads absorbed = $308,000  280,000 = $1.1
Unit production costs under absorption costing = ($1.20 + $1.40 + $0.70 + $1.1) or ($1,100,000  250,000) = $4.4
(b) Advantages:
— inventory valuations will not be distorted by the changes in current year’s fixed costs
— enables the company to concentrate on its controllable aspects by separating its fixed and
variable costs
— helps management to make production and sales decisions with the calculated marginal costs
information
HKDSE Sample 1 (Paper 2A, 9)
(Absorption and marginal Costing)
Mary is a fresh university graduate who has majored in marketing. She is enthusiastic about conducting a business of
her own alongside her full-time employment. She borrowed a sum of $90,000 from a bank at an interest rate of 5% per
annum on 1 January 20X7 to run a shop which sells free-sized T-shirts of her own design.
Information relating to the shop is as follows:
(i)
The shop’s rental is $5,000 per month. The annual rates and insurance expenses are $3,600 and $4,500
respectively.
(ii)
A shop attendant is hired at a basic salary of $7,000 per month plus a commission of 5% of the sales value.
(iii) All T-shirts are imported from factories based on the Mainland and are sold at 100% mark-up on cost.
(iv) The budgeted sales volume is 500 shirts per month. Mary has made arrangements with the Mainland suppliers for
the supply of 500 shirts each month. Then a logo sticker will be fixed on each shirt by a sewing service provider
nearby at the cost of $2 each. The purchase costs for the first quarter of 20X7 are as follows:
$
22,500
24,000
25,000
January 20X7
February 20X7
March 20X7
(v)
In order to publicise her new brand, Mary will print some promotional leaflets to be distributed once a week in
the neighborhood. The printing cost of the leaflets amounts to $500 per month and a part-time worker is hired at
$1,000 per month for the distribution work.
(vi) A point-of-sale system costing $30,000 was purchased to help keep inventory record and cash transactions. In
addition, Mary furnished the shop with necessary furniture and fixtures by spending a further $60,000.
Depreciation is to be calculated at 12% per annum on a reducing balance basis for the point-of-sale system and
10% on cost for the furniture and fixtures.
(vii) The actual sales figures for the first quarter ended 31 March 20X7 are as follows:
January 20X7
February 20X7
March 20X7
Number of shirts
350
420
400
REQUIRED:
(a)
Define direct costs and indirect costs and identify one example for each from the case above.
(b) Compare marginal costing with absorption costing with respect to inventory valuation and income determination.
(c)
Prepare an income statement for the first quarter ended 31 March 20X7 using the marginal costing method,
assuming the FIFO method is adopted in the valuation of unsold goods.
(d) With the figures you have compiled in (c) above, calculate the breakeven point (in sales dollars) of the first
quarter ended 31 March 20X7.
Noting that there are several giant enterprises in the low-margin garment market, Mary’s father has always persuaded
Mary to discontinue her small business which is unlikely to be competitive enough to survive.
REQUIRED:
(e)
Discuss two possible reasons why Mary is still enthusiastic about running a business of her own.
(a) Direct costs – costs that would be economical to trace their cost object
e.g. purchase cost, cost of stickers, sales commission
Indirect costs – costs that would not be economical to trace their cost object
e.g. printing cost, salaries, rent and rates, insurance, depreciation
(b)
Inventory
—
Marginal costing
Only variable costs are charged to units.
—
valuation
Absorption costing
Fixed costs are treated as product costs
and can be carried forward to the next
period in the value of each unit.
Income
determination
—
Fixed costs incurred will not be carried —
A proportion of the fixed costs of the
forward and the profit of the current
current period will be carried forward to
accounting period will be lower.
the next accounting period and therefore
the profit of the current accounting
period will be higher.
(c)
Income statement for the first quarter ended 31 March 20X6
$
Sales [($22,500 + $24,000 + 170 x $50) x 200%]
Opening inventories
Purchases ($22,500 + $24,000 + $25,000)
Logo stickers (1,500 x $2)
Less Closing inventories [(500 – 170) x ($50 + $2)]
Product contribution margin
Less Variable costs: Commission ($110,000 x 5%)
Contribution
Less: Fixed costs
Rent and rates ($5,000 x 3 + $3,600 x 3/12)
Insurance ($4,500 x 3/12)
Salaries ($7,000 x 3 + $1,000 x 3)
Printing costs ($500 x 3)
Depreciation [$30,000 x 12% x 3/12 + $60,000 x 10% x 3/12]
Net profit
(d) Total fixed costs = $44,925
Contribution margin ratio = $47,160  $110,000
Breakeven sales dollars = Fixed cost  Contribution margin ratio
= $44,925 / ($47,160  $110,000)
= $104,787
—
71,500
3,000
(17,160)
15,900
1,125
24,000
1,500
2,400
$
110,000
57,340
52,660
5,500
47,160
44,925
2,235
Longman Mock (2011, 8)
(Absorption and marginal Costing)
8
Genius Ltd makes a single product. The production and sales information for the year ended 31 December 2012
is as follows:
Production (units)
Sales (units)
Opening inventory (units)
Selling price per unit
Direct materials cost per unit
Direct labour hours per unit
Direct labour cost per hour
Variable factory overheads per unit
Variable distribution overheads per unit
Fixed factory overheads
Fixed administrative and distribution overheads
350,000
395,000
55,000
$130
$40
3 hours
$15
$11.8
$14.5
$1,750,000
$5,485,600
The production volume and fixed factory overheads were the same in 2011 and 2012.
Required:
(a) Calculate the unit production costs for the year ended 31 December 2012 under absorption costing and
marginal costing.
(3.5 marks)
(b) Calculate, under both absorption costing and margin costing, the following:
(i)
Manufacturing cost of goods completed
(ii) Cost of goods sold
(iii) Closing inventory
(7 marks)
(c) Prepare income statements for the year ended 31 December 2012 under both absorption costing and
margin costing.
(5 marks)
(d) Reconcile the difference in net profit between the two costing approaches.
(1.5 marks)
(e) State the effects on the net profit calculated under absorption costing and marginal costing if:
(i)
the sales volume exceeds the production volume;
(ii) the production volume exceeds the sales volume; and
(iii) the sales volume equals the production volume.
(3 marks)
(Total: 20 marks)
(a)
Direct materials
Direct labour (3  $15)
Variable factory overheads
Fixed factory overheads ($1,750,000  350,000)
Unit production costs
(b)
(i)
Absorption
costing
$
40
45
11.8
5
101.8
Marginal
costing
$
40
45
11.8
—
96.8
Manufacturing cost of goods completed under absorption costing = 350,000  101.8 = $35,630,000
Manufacturing cost of goods completed under marginal costing = 350,000  96.8 = $33,880,000
(ii)
Cost of goods sold under absorption costing = 395,000  101.8 = $40,211,000
Cost of goods sold under marginal costing = 395,000  96.8 = $38,236,000
(iii)
Opening inventory (W1)
Add Manufacturing cost of goods completed
Cost of goods available for sale
Less Cost of goods sold
Closing inventory
Absorption
costing
$
5,599,000
35,630,000
41,229,000
(40,211,000)
1,018,000
Marginal
costing
$
5,324,000
33,880,000
39,204,000
(38,236,000)
968,000
W1 Opening inventory under absorption costing = 55,000  101.8 = $5,599,000
Opening inventory under marginal costing = 55,000  96.8 = $5,324,000
(c) Under absorption costing:
Genius Ltd
Income Statement for the year ended 31 December 2012
$
Sales (395,000  $130)
Less
Cost of goods sold:
Opening inventory
Add Manufacturing cost of goods completed
Cost of goods available for sale
Less Closing inventory
Gross profit
Less
Variable distribution overheads (395,000  $14.5)
Fixed administrative and distribution overheads
Net loss
5,599,000
35,630,000
41,229,000
(1,018,000)
5,727,500
5,485,600
$
51,350,000
(40,211,000)
11,139,000
(11,213,100)
(74,100)
Under marginal costing:
Genius Ltd
Income Statement for the year ended 31 December 2012
$
Sales
Less
Variable cost of goods sold:
Opening inventory
Add Manufacturing cost of goods completed
Variable cost of goods available for sale
Less Closing inventory
Product contribution margin
Less
Variable distribution overheads
Contribution margin
Less
Fixed factory overheads
Fixed administrative and distribution overheads
Net profit
5,324,000
33,880,000
39,204,000
(968,000)
1,750,000
5,485,600
$
51,350,000
(38,236,000)
13,114,000
(5,727,500)
7,386,500
(7,235,600)
150,900
(d)
Difference in net profit = Net profit under absorption costing  Net profit under marginal costing
= $74,100  $150,900
= $225,000 (profit is lower under absorption costing)
Difference in net profit = Fixed factory overheads included in closing inventory under absorption costing
 Fixed factory overheads included in opening inventory under absorption costing
= (10,000  $5)  (55,000  $5)
=  $225,000
(e)
(i)
When the sales volume exceeds the production volume, a higher net profit figure will be
reported under marginal costing than under absorption costing.
(ii)
When the production volume exceeds the sales volume, a higher net profit figure will be
reported under absorption costing than under marginal costing.
(iii) When the sales volume equals the production volume, the net profit figure reported will be
the same under both marginal costing and absorption costing.
HKET Mock (2011, 8)
(Absorption and marginal Costing)
8. Mr. Chan just opened a shop to sell mobile phones, and at the back of the shop there is a small factory to produce
the products. He purchases electronic components from suppliers and then assembles as a mobile phone for sale.
In order to start the business, he borrowed $100,000 from the bank at a nominal interest rate 4% compounded
monthly on 1 January 20X1. Interest expense is paid quarterly.
Information related to the shop is as follow:
(i) The rent of the shop is $8,000 per month. Electricity and water expenses are $250 per month. And there is an
annual property management fee for the building of $5,000.
(ii) Mr. Chan owns this company and acts as a director. His director remuneration fee is $6,000 each month. He
hires a technician to assemble the mobile phones, and the salary is $8,000 each month.
(iii) Mr. Chan bought a computer that costs $5,000 for keeping records and an equipment that costs $3,600 for
the technician to assemble the electrical components and make them into mobile phones. No salvage values
are expected for these assets. Asset values will be totally depreciated in 5 years with straight-line method.
(iv) Each month Mr. Chan purchased electronic components from suppliers. The costs are as follow:
Jan 20X1: $5,800
Feb 20X1: $6,700
Mar 20X1: $8,200
(v) The sales figures for the first quarter ended 31 March 20X1 are as follows:
Jan 20X1: $250,000
Feb 20X1: $230,000
Mar 20X1: $280,000
(vi) Mr. Chan classifies half of the rental payment of the shop, and 80% of the electricity and water expenses as
manufacturing costs.
(vii) For the first quarter of 20X1,
the number of mobile phones produced:
the number of mobile phones sold:
REQUIRED:
350
304
(a) Identify TWO direct costs and TWO indirect costs from the case above.
(b) Prepare separated income statements for the first quarter ended 31 March 20X1 using marginal costing
method and absorption costing method respectively.
(c) State ONE advantage of marginal costing method over absorption costing method.
(d) Could Mr. Chan choose the method of costing by himself? Explain.
(e) Mr. Chan would like to boost the net profit by extending the useful life of assets in the next quarter’s income
statement. Is this acceptable in accounting principles and in ethics?
(a)
Direct costs: Direct materials – electronic components
Direct labour – technician’s salaries
Indirect costs: 80% of the monthly electricity and water expenses for manufacturing use
50% of the monthly rental expenses for manufacturing use
Depreciation for equipment
The following items are not related to manufacturing costs:
20% of the monthly electricity and water expenses not for manufacturing use
50% of the monthly rental income not for manufacturing use
Depreciation for computer
Loan interest expenses
Director remuneration fee
(b)
Income Statement for the first quarter ended 31 March 20X1 using absorption costing
$
$
Sales ($250,000 + $230,000 + $280,000)
760,000
Less: Cost of goods sold:
Direct materials ($5,800 + $6,700 + $8,200)
20,700
Direct labour (3 × $8,000)
24,000
Manufacturing overhead cost
Electricity and water expenses ($250 x 3 x 80%)
600
 Rental expenses for manufacturing ($8,000 × 3 x 0.5)
12,000
Depreciation for equipment [$3,600 ÷ 5) / 4]
180
57,480
Less: Closing inventory [(350  304) x ($57,480 / 350)]
7,555
49,925
Gross profit
710,075
Less: Non-manufacturing overhead cost
Electricity and water expenses ($250 x 3 x 20%)
150
 Rental expenses for non-manufacturing ($8,000 × 3 x 0.5)
12,000
Depreciation for computer [$5,000 ÷ 5) / 4]
250
 Loan interest [$100,000 x (1 + 4%/12)3  $100,000]
1,003
Management fee ($5,000 / 4)
1,250
Director remuneration fee ($6,000 x 3)
18,000
32,653
Net profit
677,422
Income Statement for the first quarter ended 31 March 20X1 using marginal costing
$
$
Sales ($250,000 + $230,000 + $280,000)
Less: Variable cost of goods sold:
Direct materials ($5,800 + $6,700 + $8,200)
20,700
Direct labour (3 × $8,000)
24,000
Less: Closing inventory [(350  304) x ($44,700 / 350)]
Contribution
Less: Fixed manufacturing cost
Electricity and water expenses ($250 x 3 x 80%)
 Rental expenses for manufacturing ($8,000 × 3 x 0.5)
Depreciation for equipment [$3,600 ÷ 5) / 4]
Fixed non-manufacturing cost
Electricity and water expenses ($250 x 3 x 20%)
 Rental expenses for non-manufacturing ($8,000 × 3 x 0.5)
Depreciation for computer [$5,000 ÷ 5) / 4]
 Loan interest [$100,000 x (1 + 4%/12)3  $100,000]
Management fee ($5,000 / 4)
Director remuneration fee ($6,000 x 3)
Net profit
44,700
5,875
600
12,000
180
12,780
150
12,000
250
1,003
1,250
18,000
32,653
$
760,000
38,825
721,175
45,433
675,742
(c)
Fixed costs are sunk costs. They should not be considered when managers are going to make decisions.
Any other reasonable answers.
(d)
Mr. Chan could choose either marginal costing or absorption costing.
However, marginal costing is not acceptable if Mr. Chan is going to publish the financial statement to
the public.
(e)
It is not acceptable for a professional accounting treatment.
We have to keep consistency principle on preparing financial statements. Changing rules frequently will
dampen the reliability of the financial information.
Second, professional accountants should follow the Code of Ethics of being honest, straight forward
and keeping objectivity. If the reason for extending the depreciation period is to boost up net profit, it
is not an honest act.
The integrity of the professional accountant will be in doubt.
HKDSE Sample 1 (Paper 2A, 3)
(Absorption and marginal costing)
Lau Yan Manufacturing Company has extracted the following information as at 31 December 20X6
Inventories as at 1 January 20X6:
Raw materials
Work in progress
Finished goods
Royalties (based on the number of units produced)
Depreciation charge for the year: Plant and machinery
Delivery vehicles
Office equipment
Direct labour
Purchase of raw materials
Factory manager’s salary
Rent and electricity
Administrative and selling expenses
Materials loss due to fire
$
40,800
35,000
180,000
89,000
90,200
897,560
65,377
60,800
170,000
57,000
112,500
87,300
50,000
Additional information:
(i) At 31 December 20X6, inventories were valued as follows:
$
Raw materials
77,000
Work in progress
52,000
Finished goods
175,000
(ii) It is the company’s policy to apportion two-thirds of the costs common to both the factory and the office to the
cost of production.
(iii) Finished goods are transferred to the sales department at cost plus 10%.
REQUIRED:
(a) Prepare the manufacturing account for the year ended 31 December 20X6
(b) Ascertain each of the following for the year ended 31 December 20X6
(i) Cost of raw materials consumed
(ii) Prime cost
(iii) Production cost of finished goods
(iv) Transfer price of finished goods
Answer:
(a)
Cost of raw materials consumed = $40,800 + $170,000 – ($77,000 + $50,000) = $83,800
(b)
Prime cost = $83,800 + $89,000 + $60,800 = $233,600
(c)
Production cost of finished goods
= $233,600 + ($112,500 x 2/3 + $90,200 + $57,000) + $35,000 – $52,000
= $438,800
(d)
Transfer price of finished goods = $438,800 x (1 + 10%) = $482,680
Answer:
Lau Yan Manufacturing Company
Manufacturing Account for the year ended 31 December 20X6
$
Opening inventory of raw materials
Add: Purchases
Less: Fire Loss
Less Closing inventory of raw materials
Cost of raw materials consumed
Direct labour
Royalties
Prime cost
Factory overheads: Rent and electricity ($112,500 x 2/3)
Depreciation of Plant and machinery
Factory manager’s salary
Add Opening work-in-progress
Less Closing work-in-progress
Production cost of finished goods
Mark up (10%)
Transfer price of finished goods
(a)
Cost of raw materials consumed: $83,800
(b)
Prime cost: $233,600
(c)
Production cost of finished goods: $438,800
(d)
Transfer price of finished goods: $482,680
75,000
90,200
57,000
$
40,800
170,000
210,800
50,000
160,800
77,000
83,800
60,800
89,000
233,600
222,200
455,800
35,000
490,800
52,000
438,800
43,880
482,680
HKDSE Sample 1 (Paper 2A, 9)
(Absorption and marginal costing)
Mary is a fresh university graduate who has majored in marketing. She is enthusiastic about conducting a business of
her own alongside her full-time employment. She borrowed a sum of $90,000 from a bank at an interest rate of 5% per
annum on 1 January 20X7 to run a shop which sells free-sized T-shirts of her own design.
Information relating to the shop is as follows:
(i)
The shop’s rental is $5,000 per month. The annual rates and insurance expenses are $3,600 and $4,500
respectively.
(ii)
A shop attendant is hired at a basic salary of $7,000 per month plus a commission of 5% of the sales value.
(iii) All T-shirts are imported from factories based on the Mainland and are sold at 100% mark-up on cost.
(iv) The budgeted sales volume is 500 shirts per month. Mary has made arrangements with the Mainland suppliers for
the supply of 500 shirts each month. Then a logo sticker will be fixed on each shirt by a sewing service provider
nearby at the cost of $2 each. The purchase costs for the first quarter of 20X7 are as follows:
$
22,500
24,000
25,000
January 20X7
February 20X7
March 20X7
(v)
In order to publicise her new brand, Mary will print some promotional leaflets to be distributed once a week in
the neighborhood. The printing cost of the leaflets amounts to $500 per month and a part-time worker is hired at
$1,000 per month for the distribution work.
(vi) A point-of-sale system costing $30,000 was purchased to help keep inventory record and cash transactions. In
addition, Mary furnished the shop with necessary furniture and fixtures by spending a further $60,000.
Depreciation is to be calculated at 12% per annum on a reducing balance basis for the point-of-sale system and
10% on cost for the furniture and fixtures.
(vii) The actual sales figures for the first quarter ended 31 March 20X7 are as follows:
January 20X7
February 20X7
March 20X7
Number of shirts
350
420
400
REQUIRED:
(a)
Define direct costs and indirect costs and identify one example for each from the case above.
(b) Compare marginal costing with absorption costing with respect to inventory valuation and income determination.
(c)
Prepare an income statement for the first quarter ended 31 March 20X7 using the marginal costing method,
assuming the FIFO method is adopted in the valuation of unsold goods.
(d) With the figures you have compiled in (c) above, calculate the breakeven point (in sales dollars) of the first
quarter ended 31 March 20X7.
Noting that there are several giant enterprises in the low-margin garment market, Mary’s father has always persuaded
Mary to discontinue her small business which is unlikely to be competitive enough to survive.
REQUIRED:
(e)
Discuss two possible reasons why Mary is still enthusiastic about running a business of her own.
(a) Direct costs – costs that would be economical to trace their cost object
e.g. purchase cost, cost of stickers, sales commission
Indirect costs – costs that would not be economical to trace their cost object
e.g. printing cost, salaries, rent and rates, insurance, depreciation
(b)
Inventory
—
Marginal costing
Only variable costs are charged to units.
—
valuation
Absorption costing
Fixed costs are treated as product costs
and can be carried forward to the next
period in the value of each unit.
Income
determination
—
Fixed costs incurred will not be carried —
A proportion of the fixed costs of the
forward and the profit of the current
current period will be carried forward to
accounting period will be lower.
the next accounting period and therefore
the profit of the current accounting
period will be higher.
(c)
Income statement for the first quarter ended 31 March 20X6
$
Sales [($22,500 + $24,000 + 170 x $50) x 200%]
Opening inventories
Purchases ($22,500 + $24,000 + $25,000)
Logo stickers (1,500 x $2)
Less Closing inventories [(500 – 170) x ($50 + $2)]
Product contribution margin
Less Variable costs: Commission ($110,000 x 5%)
Contribution
Less: Fixed costs
Rent and rates ($5,000 x 3 + $3,600 x 3/12)
Insurance ($4,500 x 3/12)
Salaries ($7,000 x 3 + $1,000 x 3)
Printing costs ($500 x 3)
Depreciation [$30,000 x 12% x 3/12 + $60,000 x 10% x 3/12]
Net profit
(d) Total fixed costs = $44,925
Contribution margin ratio = $47,160  $110,000
Breakeven sales dollars = Fixed cost  Contribution margin ratio
= $44,925 / ($47,160  $110,000)
= $104,787
—
71,500
3,000
(17,160)
15,900
1,125
24,000
1,500
2,400
$
110,000
57,340
52,660
5,500
47,160
44,925
2,235
AAT 2011 (Pilot Paper 2, 5)
(Absorption and marginal costing)
5. i-M Limited has provided the following data concerning last month’s manufacturing operations.
Purchases of raw materials
$53,000
Indirect materials used in manufacturing
$8,000
Direct labour ($25 per hour)
$62,000
Manufacturing overhead incurred (excluded indirect materials)
$32,000
Inventories:
Beginning
$
24,000
41,000
86,000
Raw materials
Work in process
Finished goods
Ending
$
6,000
38,000
93,000
Annual budgeted manufacturing overhead is $360,000 which is based on 30,000 budgeted direct labour hours.
REQUIRED:
(a)
Prepare a Schedule of Cost of Goods Manufactured for last month.
(b)
Prepare a Schedule of Cost of Goods Sold for last month.
(c)
What is the purpose of the job cost sheet in a job costing?
5 (a)
i-M Limited
Schedule of Cost of Goods Manufactured
Opening inventory of raw materials
Add: Purchases of raw materials
Total raw materials available
Less: Closing inventory of raw materials
Direct manufacturing costs
Less Indirect materials included in actual manufacturing overhead
Direct labour
Prime cost
Manufacturing overhead absorbed ($360,000/30,000 x $62,000/25)
Add: Work in process inventory, beginning
$
24,000
53,000
77,000
6,000
71,000
8,000
Indirect manufacturing costs
including indirect materials
Less: Work in process inventory, ending
Manufacturing cost of goods completed
$
63,000
62,000
125,000
29,760
154,760
41,000
195,760
38,000
157,760
(b)
i-M Limited
Schedule of Cost of Goods Sold
Finished goods inventory, beginning
Add: Manufacturing cost of goods completed
Goods available for sale
Less: Finished goods inventory, ending
excluding indirect materials
Add: Under-absorbed manufacturing overhead [($32,000$8,000)$29,760]
Cost of goods sold
$
86,000
157,760
243,760
93,000
150,760
10,240
161,000
(c) —
The job cost sheet is used to record all costs that are assigned to a particular job. These costs
include direct materials and direct labour costs traced to the job and manufacturing overhead
cost applied to the job.
— When a job is completed, the job cost sheet is used to compute the unit product cost.
— The job cost sheet is also a control document for determining (1) how many units have been
sold and the cost of these units and (2) how many units are still in inventory at the end of a
period and the cost of these units on the statement of financial position.
(HKALE 2008 P2 4)
(Absorption and marginal costing)
Sun Ltd commenced the production of Product X in March 2008. It has the following information relating to March 2008:
Sales
Raw material
Direct labour
Production overheads
Budgeted at
50,000 units
$
1,500,000
400,000
500,000
380,000
Budgeted at
80,000 units
$
2,400,000
640,000
800,000
518,000
REQUIRED:
(a) Using the marginal costing approach, prepare for Sun Ltd an income statement of 70,000 units.
(b) Explain two advantages of using absorption costing approach for stock valuation.
(a)
Trading account for the month ended 31 March 2008 (flexed at 70,000 units)
Sales ($30  70,000)
Raw material (70,000 x $8)
Labour (70,000 x $10)
Variable production overhead (70,000 x $4.6)
Contribution
Fixed production overheads
Profit
$
2,100,000
560,000
700,000
322,000
518,000
150,000
368,000
Selling price per unit = $1,500,000 / 50,000 = $2,400,000 / 80,000 = $30
Raw material per unit = $640,000 / 80,000 = $400,000 / 50,000 = $8
Labour per unit = $800,000 / 80,000 = $500,000 / 50,000 = $10
Variable production overhead per unit = ($518,000  $380,000) / (80,000 – 50,000) = $4.6
Fixed production overhead = $380,000 – 50,000 x $4.6 = $150,000
(b)
—
Including both fixed and variable manufacturing costs in inventory valuation can better reflect the costs
incurred to produce goods.
—
Distinguishing between manufacturing and non- manufacturing costs is easier than distinguishing
between fixed and variable costs.
HKCEE (2007, 6)
(Absorption and marginal costing)
Ernest and Fred are in partnership sharing profit and losses in the ratio of 3:2 respectively. The following balances were extracted
from the books as at 31 March 2007:
Machinery, at cost
Office equipment, at cost
Accumulated depreciation, 1 April 2006
Machinery
Office equipment
Stock, 1 April 2006
Raw materials
Work in progress
Finished goods
Sales
Trade debtors
Trade creditors
Carriage inwards
Returns inwards
Wages and salaries
Purchases of raw materials
Administrative expenses
Selling expenses
Provision for doubtful debts, 1 April 2006
Cash at bank
Capital accounts, 1 April 2006
Ernest
Fred
Current accounts, 1 April 2006
Ernest
Fred
Drawings
Ernest
Fred
8% loan – Fred (borrowed on 1 October 2006)
Interest on 8% loan
Repairs to machinery
Rent and rates (factory 1/4; office 3/4)
Carriage outwards
$
751,500
502,800
333,160
254,800
81,100
46,610
163,750
2,741,200
136,400
196,670
19,020
26,120
675,240
1,005,600
120,930
92,690
3,760
72,540
180,000
150,000
20,000
30,000
(Dr)
15,000
12,000
150,000
3,330
5,320
275,800
13,840
Additional information:
(i)
Stock as at 31 March 2007:
Raw materials
Work in progress
Finished goods
$
67,490
52,140
170,300
A damaged and worthless item with a cost of $280 was included in the finished goods.
(ii)
Depreciation is to be charged as follows:
Machinery – 20% per annum on a straight-lines basis
Office equipment – 10% per annum on a reducing-balance basis
(iii)
Interest on partners’ capital is to be calculated at 5% per annum.
(iv)
Cash purchases of raw materials for the partnership at a cost of $5,200 had been recorded as Ernest’s drawings.
(v)
No entries had been made in respect of a cash sale of $1,000, of which the proceeds were retained by Fred.
(vi)
The following adjustments were to be made on 31 March 2007:
$
Accrued rent and rates
4,200
Prepaid wages to direct labour
2,500
Bonus to Fred
50,000
Provision for doubtful debts was to be maintained at 5% of trade debtors.
(vii)
Analysis of the wages and salaries revealed:
Direct labour
Indirect labour
Factory supervisor
Office staff
Salaries to Ernest
Salaries to Fred
$
200,000
80,040
72,000
143,200
80,000
100,000
675,240
(viii) A sale of office equipment on credit for $30,000 on 31 March 2007 had not yet been recorded. The office equipment had a
cost of $84,000 and an accumulated depreciation of $56,000 at 1 April 2006.
You are required to:
Prepare the following accounts of the partnership for the year ended 31 March 2007:
(a) the manufacturing account, showing clearly the cost of raw materials consumed, the prime cost and the production cost of
finished goods;
(a)
Ernest and Fred
Manufacturing account for the year ended 31 March 2007
$
Opening stock
Add: Purchases ($1,005,600 + $5,200)
Carriage inwards
Less Closing stock
Raw materials consumed
Direct labour ($200,000 – $2,500)
Prime cost
Factory overheads
Indirect labour
Salaries to factory supervisor
Repairs to machinery
Rent and rates [($275,800 + $4,200) x 1/4]
Depreciation – machinery ($751,500 x 20%)
Add Opening work-in-progress
Less Closing work-in-progress
Production cost of finished goods
1,010,800
19,020
80,040
72,000
5,320
70,000
150,300
$
81,100
1,029,820
1,110,920
67,490
1,043,430
197,500
1,240,930
377,660
1,618,590
46,610
1,665,200
52,140
1,613,060
(HKALE 2005, Paper 2, 2)
(Absorption and marginal Costing)
Yellow Stone Manufacturing Ltd commenced business in 2004 producing cleaning liquid Product X. Each bottle of Product X
contains 1 litre of raw materials.
The production budget for the year ended 31 December 2004 on the basis of 100,000 bottles is shown below:
$
Raw materials ($10 per litre)
1,000,000
Direct labour ($2 per labour hour)
800,000
200,000
Factory overheads fixed
Other budget information:
Selling and distribution expenses:
Fixed
Variable
Administrative expensesfixed
Selling price
Sales volume
$150,000
$1 per bottle
$400,000
$30 per bottle
90,000 bottles
Required:
(a) (i) Prepare the budgeted income statement for Product X based on absorption costing to show the budgeted net profit for
the year ended 31 December 2004.
(ii) How will the budgeted net profit differ if marginal costing is used instead?
Answer:
(a) (i)
Product X
Budgeted income statement for the year ended 31 December 2004
$
Sales (90,000 × $30)
Less Cost of goods sold:
Raw materials
Direct labour
Factory overheads
Less Closing stock ($2,000,000 x 10,000/100,000)
Expenses
Selling and distribution expenses ($150,000 + 90,000 x $1)
Administrative expenses
Budgeted net profit
(ii)
1,000,000
800,000
200,000
2,000,000
(200,000)
240,000
400,000
$
2,700,000
(1,800,000)
900,000
640,000
260,000
Under marginal costing, the fixed factory overheads will not be absorbed into the closing stock but
are written off as expenses. The value of closing stock will therefore be lower to $180,000
($1,800,000 x 10,000/100,000), resulting in a corresponding reduction of budgeted net profit by
$20,000.
During the year 2004, $240,000 was incurred for the research and development of a new Product Y. The variable production costs
for each bottle of Product Y are:
Raw materials
Direct labour
$11
$24
The experience in 2004 shows that the company has spare capacity to deal with additional production. If the company maintains
the production level of Product X at 120,000 bottles in 2005, it will be able to produce and sell 50,000 bottles of Product Y, and the
following additional expenses are required for 2005:
Selling and distribution expenses
Fixed
Variable
Administrative expenses
$70,000
$2 per bottle of Product Y
$80,000
An engineer would be redeployed from another unit to supervise the production of Product Y, if any, in 2005. He would be paid at
the current salary of $150,000 per annum and would return to his original post when Product Y ceases production. Product Y can
be sold at $44 per bottle. However, Product Y will be sold for one year only because another new product will be launched in 2006.
The whole amount of the development cost will be written off in 2005.
Required:
(b) Calculate the contribution per unit of Product Y.
(c) Indicate whether each of the following items is a relevant cost or an irrelevant cost:
(i) The research and development costs
(ii) The additional expenses
(iii) The engineer’s salary
(d) As Product Y will be sold for one year in 2005 only, analyse the costs above and advise with supporting calculations whether
the company should produce Product Y in 2005.
(b) Contribution per unit of Product Y
$
44
(11)
(24)
(2)
7
Selling price per unit
Raw materials
Direct labour
Variable selling and distribution expenses
Contribution per unit
(c) (i)
Irrelevant cost: The $240,000 research and development is sunk cost and should be ignored for
decision making.
(ii) Relevant cost: The additional expenses will be incurred when Product Y is produced.
(iii) Irrelevant cost: The engineer’s salary of $150,000 is irrelevant to the decision as it does not
represent incremental cost to the company.
(d) Additional profit of producing Product Y
Total contribution (50,000 bottles x $7)
Additional overheads
Fixed selling and distribution
Administrative expenses
Additional profit
$
350,000
(70,000)
(80,000)
200,000
As product Y will generate an additional profit of $200,000, the company should produce and sell
product Y even it has a product life of one year only.