Marginal costing and absorption costing

Question 1

The following cost details relate to one unit of product MC.

Per unit;
Variable materials = 9.80
Variable labour = 8.70

Production overheads
Variable = 1.35
Fixed = 9.36

Selling and distribution overheads
Variable = 7.49
Fixed = 3.40
——
Total cost 40.10

In a marginal costing system, the value of a closing inventory of 4,300 units of product MC will be
A - £85,353
B - £117,562
C - £125,603
D - £172,430

Answer 1

A - £85,353

Variable materials 9.80
Variable labour 8.70
Variable production overheads 1.35
Variable production cost per unit 19.85
Value of inventory in a marginal costing system = £19.85 × 4,300 units
= £85,355

Question 2

A company manufactures product S and product T
The following information relates to the latest period.

Product S:
Variable labour cost per unit: £60
Other variable production costs per unit £70
Budgeted production units 3,400
Labour hours: 17,000

Product T:
Variable labour cost per unit: £48
Other variable production costs per unit: £50
Budgeted production units: 4,000
Labour hours: 16,000

Variable labour is paid at £12 per hour.
Fixed production overhead incurred of £214,500 was the same as budgeted for the period. Fixed
production overhead is absorbed on the basis of labour hours.

Fixed production overhead absorption rate = £214,500/(17,000 + 16,000)
= £6.50 per labour hour

The value of the closing inventory of product S using absorption costing was £65,000.

If marginal costing had been used the value of this inventory would have been
A - £52,000
B - £53,150
C - £260,000
D - £442,000

Answer 2

A - £52,000

The value of this inventory using marginal costing would have been £52,000

Fixed production overhead per unit of product S = £6.50 × (£60/£12) hours
= £32.50 per unit
Full production cost per unit of product S = £(32.50 + 60.00 + 70.00)
= £162.50
Number of units of product S in inventory = £65,000/£162.50
= 400 units
Marginal costing valuation of inventory = 400 × (£60 + £70)
= £52,000

Question 3

Ticktock Ltd makes clocks with a selling price of £50 per clock. Budgeted production and sales
volume is 1,000 clocks per month. During September 1,000 clocks were made and 800 clocks were
sold. There was no opening inventory.

The variable cost per clock is £25. Fixed costs in September were, as budgeted, £5,000

Using marginal costing the contribution and profit for September would be calculated as:
A - Contribution: £25,000, Profit: £20,000
B - Contribution: £20,000, Profit: £15,000
C - Contribution: £20,000, Profit: £16,000
D - Contribution: £25,000, Profit: £16,000

Answer 3

B - Contribution: £20,000, Profit: £15,000

Contribution = 800 clocks × £(50 – 25) = £20,000
Profit = £20,000 – £5,000 fixed costs = £15,000

Question 4

Which three of the following statements concerning marginal costing are true?

A - Marginal costing is an alternative method of costing to absorption costing.
B - Contribution is calculated as sales revenue minus fixed cost of sales.
C - Closing inventories are valued at full production cost.
D - Fixed costs are treated as a period cost and are charged in full to the income statement of the
accounting period in which they are incurred.
E - Marginal cost is the cost of a unit which would not be incurred if that unit were not produced

Answer 4

A - Marginal costing is an alternative method of costing to absorption costing.
D - Fixed costs are treated as a period cost and are charged in full to the income statement of the accounting period in which they are incurred.
E - Marginal cost is the cost of a unit which would not be incurred if that unit were not produced

Contribution is calculated as sales revenue minus all variable costs (and not fixed cost of sales).
Closing inventories are valued at marginal production cost (and not full production cost).

Question 5

Which two of the following statements concerning marginal costing systems are true?

A - Such systems value finished goods at the variable cost of production.
B - Such systems incorporate fixed overheads into the value of closing inventory.
C - Such systems necessitate the calculation of under- and over-absorbed overheads.
D - Such systems write off fixed overheads to the income statement in the period in which they were
incurred

Answer 5

A - Such systems value finished goods at the variable cost of production
D - Such systems write off fixed overheads to the income statement in the period in which they were incurred

Question 6

A company budgets during its first year of operations to produce and sell 15,900 units per quarter of
its product at a selling price of £24 per unit.

Budgeted costs are as follows: (PER UNIT)

Variable production costs 8.50
Fixed production costs 2.50
Variable selling costs 6.00

In the first quarter the unit selling price, variable unit cost and expenditure on fixed production costs
were as budgeted. The sales volume was 16,000 units and closing inventory was 400 units.

The absorption costing profit for the quarter was:
A - £110,750
B - £112,000
C - £112,250
D - £113,250

Answer 6

D - £113,250

Gross profit (16,000 units × £(24.00 – 8.50 – 2.50)) 208,000
Selling costs (16,000 units × £6) (96,000)
112,000
Over absorbed fixed production costs
(16,400 units produced – 15,900 budgeted) × £2.50 1,250
————-
Absorption costing profit 113,250

Question 7

Which of the following statements about profit measurement under absorption and marginal costing
is true (assuming unit variable and fixed costs are constant)?

A - Profits measured using absorption costing will be higher than profits measured using marginal
costing.
B - Profits measured using absorption costing will be lower than profits measured using marginal
costing.
C - Profits measured using absorption costing will be either lower or higher than profits measured
using marginal costing.
D - Profits measured using absorption costing may be the same as, or lower than, or higher than
profits measured using marginal costing.

Answer 7

D - Profits measured using absorption costing may be the same as, or lower than, or higher than
profits measured using marginal costing.

Whether profits under absorption costing are the same as, lower than or higher than profits under marginal costing depends entirely on opening and closing inventory figures. For example, if there is no opening or closing inventory, then the two measures of profit will be the same.

Question 8

If the number of units of finished goods inventory at the end of a period is greater than that at the
beginning, marginal costing inventory will result in (assuming unit variable and fixed costs are
constant)

A - less operating profit than the absorption costing method
B - the same operating profit as the absorption costing method
C - more operating profit than the absorption costing method
D - more or less operating profit than the absorption costing method depending on the ratio of
fixed to variable costs

Answer 8

A - less operating profit than the absorption costing method

Question 9

Adams Ltd’s budget for its first month of trading, during which 1,000 units are expected to be
produced and 800 units sold, is as follows:

Variable production costs = 95,500
Fixed production costs = 25,800

Selling price is £250 per unit

The profit calculated on the absorption cost basis compared with the profit calculated on the marginal cost basis is:
A - £24,260 lower
B - £5,160 higher
C - £5,160 lower
D - £24,260 higher

Answer 9

B - £5,160 higher

Since production exceeded sales the inventory of 200 units carried forward to the next period would include fixed production costs of (200 × (£25,800/1,000)) = £5,160 with absorption costing.

Question 10

Bright makes and sells boats. The budget for Bright’s first month of trading showed the following:
Variable production cost of boats 45,000
Fixed production costs 30,000
—————-
Production cost of 750 boats 75,000
Closing inventory of 250 boats (25,000)
————
Production costs of 500 boats sold 50,000

Sales revenue 90,000
Production cost of boats sold (50,000)
Variable selling costs (5,000)
Fixed selling costs (25,000)
————
Profit 10,000

The budget has been produced using an absorption costing system.

If a marginal costing system were used, the budgeted profit would be
A - £22,500 lower
B - £10,000 lower
C - £10,000 higher
D - £22,500 higher

Answer 10

B - £10,000 lower

The marginal costing profit is lower because with absorption costing some of the fixed production costs would be carried forward in the inventory valuation.

Profit difference = 250 units in inventory × (£30,000/750)
= £10,000

Question 11

A company produces a single product for which cost and selling price details are as follows:

(£ per unit)
Selling price 28
Variable material (10)
Variable labour (4)
Variable overhead (2)
Fixed overhead (5)
——
Profit per unit 7

Last period, 8,000 units were produced and 8,500 units were sold. The opening inventory was 3,000
units and profits reported using marginal costing were £60,000.

The profits reported using an absorption costing system would be:
A - £47,500
B - £57,500
C - £59,500
D - £62,500

Answer 11

B - £57,500

Sales volume exceeded production volume by 500 units, therefore inventories reduced. The absorption costing profit will be lower than the marginal costing profit because fixed overheads were ‘released’ from inventory.

= inventory reduction in units × fixed overhead
per unit
Profit difference = 500 × £5 = £2,500
Absorption costing profit = £60,000 – £2,500
= £57,500

Question 12

Typo Ltd’s budget for the year ended 31 December 20X8 is as follows.

Sales 1,200 units = £24,000

Opening inventory 500 units
Production 1,000 units
—-
1,500
Closing inventory (300)
Sold 1,200 units

Marginal cost per unit £15 = (£18,000)
Contribution £6,000
Fixed overhead (£7,000)
——-
Loss (£1,000)

For absorption costing purposes, the fixed overhead absorption rate is set at £7 per unit for 20X8.
If absorption costing were to be used in inventory valuation throughout 20X8, what would the profit
(or loss) be for 20X8?

A - £400 loss
B - £400 profit
C - £2,400 profit
D - £2,400 loss

Answer 12

D - £2,400 loss

Change in inventory = 200 units reduction.
Profit difference = 200 units × £7
= £1,400

Since inventory reduced the absorption costing profit would be lower than the marginal costing profit. This would increase the loss from £1,000 to £2,400

Question 13

A company had opening inventory of 48,500 units and closing inventory of 45,500 units. Profits
based on marginal costing were £315,250 and on absorption costing were £288,250

What is the fixed overhead absorption rate per unit?
A - £5.94
B - £6.34
C - £6.50
D - £9.00

Answer 13

D - £9.00

Decrease in inventory levels = 48,500 – 45,500
= 3,000 units
Difference in profits = £315,250 – £288,250
= £27,000
Fixed overhead per unit = £27,000/3,000
= £9 per unit

Question 14

In March, a company had a marginal costing profit of £78,000. Opening inventories were 760 units
and closing inventories were 320 units. The company is considering changing to an absorption
costing system

What profit would be reported for March, assuming that the fixed overhead absorption rate is £5 per
unit?
A - £74,200
B - £75,800
C - £76,400
D - £80,200

Answer 14

B - £75,800

Decrease in inventory levels = 760 – 320
= 440 units
Difference in profits = 440 × £5 fixed overhead per unit
= £2,200

Inventories decreased, therefore the absorption costing profit would be lower as overheads are ‘released’ from inventory.

Absorption costing profit = £78,000 – £2,200
= £75,800

Question 15

When comparing the profits reported under marginal and absorption costing when the levels of
inventories increased (assuming unit variable and fixed costs are constant)

A - absorption costing profits will be lower and closing inventory valuations higher than those under
marginal costing
B - absorption costing profits will be lower and closing inventory valuations lower than those under
marginal costing
C - absorption costing profits will be higher and closing inventory valuations lower than those under
marginal costing
D - absorption costing profits will be higher and closing inventory valuations higher than those
under marginal costing

Answer 15

D - absorption costing profits will be higher and closing inventory valuations higher than those
under marginal costing

Closing inventory valuations are always higher with absorption costing because of the inclusions of fixed overhead. Therefore, the statements that closing inventory valuations are lower are incorrect.
If inventories increase, absorption costing profits are higher because of the fixed overhead being carried forward in inventory.

Question 16

Which two of the following statements are advantages of marginal costing as compared with
absorption costing?

A - It complies with accounting standards
B - It ensures the company makes a profit
C - It is more appropriate for short-term decision-making
D - Fixed costs are treated in accordance with their nature (ie, as period costs)
E - It is more appropriate when there are strong seasonal variations in sales demand

Answer 16

C - It is more appropriate for short-term decision-making
D - Fixed costs are treated in accordance with their nature (ie, as period costs)

Question 17

When comparing the profits reported under marginal and absorption costing when the levels of
inventories decreased (assuming unit variable and fixed costs are constant)

A - absorption costing profits will be lower and closing inventory valuations higher than those under
marginal costing
B - absorption costing profits will be lower and closing inventory valuations lower than those under
marginal costing
C - absorption costing profits will be higher and closing inventory valuations lower than those under
marginal costing
D - absorption costing profits will be higher and closing inventory valuations higher than those
under marginal costing

Answer 17

A - absorption costing profits will be lower and closing inventory valuations higher than those under
marginal costing

Closing inventory valuations are always higher with absorption costing because of the inclusions of fixed overhead. Therefore, the statements that closing inventory valuations are lower are incorrect.

Question 18

Which two of the following statements are correct?

A - Absorption unit cost information is the most reliable as a basis for pricing decisions.
B - A product showing a loss under absorption costing will also make a negative contribution under
marginal costing.
C - When closing inventory levels are higher than opening inventory levels and overheads are
constant, absorption costing gives a higher profit than marginal costing.
D - In a multi-product company, smaller volume products may cause a disproportionate amount of
set up overhead cost.
E - Marginal unit cost information is normally the most useful for external reporting purposes.

Answer 18

C - When closing inventory levels are higher than opening inventory levels and overheads are constant, absorption costing gives a higher profit than marginal costing.
D - In a multi-product company, smaller volume products may cause a disproportionate amount of set up overhead cost.

The statement ‘When closing inventory levels are higher than opening inventory levels and overheads are constant, absorption costing gives a higher profit than marginal costing’ is true because an increase in inventory levels will mean that with absorption costing more overhead is being carried forward at the end of the period than at the start of the period. This means that overheads charged against profit in the period would be lower than under marginal costing thereby increasing the reported profit.

The statement ‘In a multi-product company, smaller volume products may cause a disproportionate amount of set up overhead cost’ is true because overheads would normally be apportioned based on the time a product spends on the production line. For smaller volume products the time taken to set up the product run becomes a larger proportion of the total time spent in production than for higher volume products.

Question 19

Iddon Ltd makes two products, Pye and Tan, in a factory divided into two production departments,
Machining and Assembly. Both Pye and Tan need to pass through the Machining and Assembly
departments. In order to find a fixed overhead cost per unit, the following budgeted data are
relevant:

Machining:
Fixed overhead costs: £120,000
Labour hours per unit:
Pye - 0.5 hours
Tan - 1.0 hours

Assembly:
Fixed overhead costs: £72,000
Labour hours per unit:
Pye - 0.2 hours
Tan - 0.25 hours

Budgeted production is 4,000 units of Pye and 4,000 units of Tan (8,000 units in all) and fixed
overheads are to be absorbed by reference to labour hours

What is the budgeted fixed overhead cost of a unit of Pye?
A - £18
B - £20
C - £24
D - £28

Answer 19

A - £18

Number of hours in Machining are:
Hours
Pye 4,000 × 0.5 = 2,000
Tan 4,000 × 1.0 = 4,000
—
6,000

Total Machining overhead is £120,000 or £120,000/6,000 per hour = £20 per hour
Machining overhead cost of a unit of Pye is £20 × 0.5 = £10

Number of hours in Assembly are:
Pye 4,000 × 0.20 = 800
Tan 4,000 × 0.25 = 1,000
1,800

Total Assembly overhead is £72,000 or £72,000/1,800 per hour = £40 per hour
Assembly overhead cost of a unit of Pye is £40 × 0.2 = £8
Total overhead cost of a unit of Pye is therefore £10 (Machining) + £8 (Assembly) = £18

Question 20

Norbury plc has just completed its first year of trading. The following information has been collected
from the accounting records:

Variable cost per unit:
Manufacturing 6.00
Selling and administration 0.20
Fixed costs:
Manufacturing 90,000
Selling and administration 22,500

Production was 75,000 units and sales were 70,000 units. The selling price was £8 per unit
throughout the year.

Calculate the net profit for the year using absorption costing.
A - £13,500
B - £19,500
C - £21,000
D - £22,500

Answer 20

B - £19,500

The manufacturing cost per unit, on an absorption costing basis, is:
£6.00 + (£90,000/75,000) =
£6.00 + £1.20 = £7.20
The cost of sales is therefore 70,000 × £7.20 = £504,000
The sales revenue is 70,000 × £8 = £560,000
The profit before selling and administration costs is therefore £560,000 – £504,000 = £56,000
The selling and administration costs are (70,000 × £0.20) + £22,500 = £36,500
The net profit is therefore £56,000 – £36,500 = £19,500