ACCA F2 Management Accounting - 2010 - Study text - Emile Woolf Publishing
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Chapter 7: Accounting for costs: ledger entries
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Completing the cost accounting income statement
The finished goods account
The cost of sales account and the sales account
The cost accounting income statement
4 Completing the cost accounting income statement
The cost ledger includes an income statement where sales are matched with the cost
of sales. Other adjustments, such as an adjustment for under- or over-absorbed
overheads, are also recorded in the income statement, and the balance on the
account is the profit or loss for the period.
4.1 The finished goods account
The finished goods account records the production cost of finished goods completed
in the period, and the production cost of goods sold in the period.
Finished goods account
$
$
Opening inventory b/f 18,000
Cost of sales 95,000
Work-in-progress
(= cost of completed production)
87,000
Closing inventory
c/f
10,000
105,000
105,000
Opening inventory b/f 10,000
4.2 The cost of sales account and the sales account
The cost of sales account records the total cost of sales in the period – the production
cost of sales and administration and sales and distribution overheads.
Cost of sales account
$
$
Finished goods
(= production cost of goods sold)
95,000
Income statement
(= cost of sales)
155,000
Administration overheads 20,000
Sales and distribution overheads 40,000
155,000
155,000
Sales are recorded in a sales account, and then transferred to the income statement
at the end of each costing period.
Sales account
$
$
Income statement 200,000
Financial ledger control
account (= sales in the period)
200,000
200,000
200,000
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4.3 The cost accounting income statement
The profit or loss is recorded in a cost accounting income statement. The income
statement also includes any other adjustments to profit, such as under- or over-
absorbed overhead, abnormal loss or gain, or standard cost variances.
The balance on the income statement is the profit or loss for the period. The
matching double entry is in the financial ledger control account (accumulated
profits).
Cost accounting income statement
$
$
Cost of sales 155,000
Sales 200,000
Under-absorbed overheads 3,000
Profit 42,000
200,000
200,000
Exercise 2
Record the following transactions in the cost ledger accounts.
Prepare a statement of the closing balances.
$
Opening balances:
Materials 7,000
Work-in-progress 3,000
Finished goods 4,000
Financial ledger control account 14,000
Transactions in the period
Material purchases 50,000
Direct materials used in production 33,000
Indirect production materials 17,000
Indirect materials: other overheads 2,000
Wages and salaries costs 45,000
Direct labour costs 28,000
Indirect production labour 7,000
Indirect labour: other overheads 10,000
Expenses: production overheads 24,000
Expenses: other overheads 15,000
Production overheads absorbed 50,000
Closing inventory, work-in-progress 8,000
Production cost of goods sold 109,000
Sales 160,000
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Paper F2
Management Accounting
CHAPTER
8
Marginal costing and
absorption costing
Contents
1 Marginalcostandmarginalcosting
2 Reportingprofitwithmarginalcosting
3 Marginalcostingandabsorptioncosting
compared
4 Advantagesanddisadvantagesofabsorptionand
marginalcosting
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Marginal cost and marginal costing
Marginal cost
Marginal costing and its uses
Assumptions in marginal costing
Contribution
1 Marginal cost and marginal costing
1.1 Marginal cost
The marginal cost of an item is its variable cost.
Marginal production cost = Direct materials + Direct labour + Variable
production overhead.
Marginal cost of sale for a product = Direct materials + Direct labour + Variable
production overhead + Other variable overhead (for example, variable selling
and distribution overhead).
Marginal cost of sale for a service = Direct materials + Direct labour + Variable
overhead.
It is usually assumed that direct labour costs are variable (marginal) costs, but in
some situations, direct labour costs might be fixed costs, and so would not be
included in marginal cost.
Variable overhead costs might be difficult to identify. In practice, variable
overheads might be measured using a technique such as high/low analysis or linear
regression analysis, to separate total overhead costs into fixed costs and a variable
cost per unit of activity.
For variable production overheads, the unit of activity is often either direct
labour hours or machine hours, although another measure of activity might be
used.
For variable selling and distribution costs, the unit of activity might be sales
volume or sales revenue.
Administration overheads are usually considered to be fixed costs, and it is very
unusual to come across variable administration overheads.
Marginal costs and total costs
When marginal costing is used, total costs are the sum of variable costs (marginal
costs) and fixed costs. It is important in marginal costing that you should separate
variable costs from fixed costs, and identify them separately. Remember that there
might be some variable selling and distribution costs. The table below shows how
variable and fixed costs might be separated in a marginal costing analysis.
Chapter 8: Marginal costing and absorption costing
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$
$
Direct materials
60,000
Direct labour
40,000
Direct expenses
5,000
Prime cost
105,000
Variable production overheads
15,000
Variable selling and distribution overheads
10,000
Total variable costs (marginal cost)
130,000
Fixed costs
Fixed production overheads 60,000
Fixed administration overheads 40,000
Fixed selling and distribution overheads 50,000
Fixed costs
150,000
Total costs
280,000
1.2 Marginal costing and its uses
Marginal costing is a method of costing with marginal costs. It is an alternative to
absorption costing as a method of costing. In marginal costing, fixed production
overheads are not absorbed into product costs.
There are several reasons for using marginal costing:
To measure profit (or loss), as an alternative to absorption costing
To forecast what future profits will be
To calculate what the minimum sales volume must be in order to make a profit
It can also be used to provide management with information for decision making.
This chapter looks at using marginal costing to measure profit, as an alternative to
absorption costing.
Its main uses, however, are for planning (for example, budgeting), forecasting and
decision making.
1.3 Assumptions in marginal costing
For the purpose of marginal costing, the following assumptions are normally made:
Every additional unit of output or sale, or every additional unit of activity, has
the same variable cost as every other unit. In other words, the variable cost per
unit is a constant value.
Fixed costs are costs that remain the same in total in each period, regardless of
how many units are produced and sold.
Costs are either fixed or variable, or a mixture of fixed and variable costs. Mixed
costs can be separated into a variable cost per unit and a fixed cost per period.
Techniques such as high/low analysis or linear regression analysis should be
used to do this.
The marginal cost of an item is therefore the extra cost that would be incurred by
making and selling one extra unit of the item.
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1.4 Contribution
Contribution is a key concept in marginal costing.
Contribution = Sales – Variable costs
Fixed costs are a constant total amount in each period. To make a profit, an entity
must first make enough contribution to cover its fixed costs. Contribution therefore
means: ‘contribution towards covering fixed costs and making a profit’.
Total contribution – Fixed costs = Profit
When fixed costs have been covered, any additional contribution adds directly
to profit.
If total contribution fails to cover fixed costs, there is a loss.
Chapter 8: Marginal costing and absorption costing
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Reporting profit with marginal costing
Total contribution minus fixed costs
A marginal costing income statement with opening and closing inventory
2 Reporting profit with marginal costing
2.1 Total contribution minus fixed costs
With marginal costing, profit is measured as follows (illustrative figures are shown):
When you are measuring profits using marginal costing, it is usual to identify
contribution, and then to subtract fixed costs from the total contribution in order to
get to the profit figure. An simplified example of a marginal costing income
statement is shown below.
$
$
Sales
360,000
Direct costs 105,000
Variable production costs 15,000
Variable sales and distribution costs 10,000
Total marginal costs
130,000
Total contribution
230,000
Total fixed costs
150,000
Profit
80,000
Total contribution and contribution per unit
In marginal costing, it is assumed that the variable cost per unit of product (or per
unit of service) is constant. If the selling price per unit is also constant, this means
that the contribution earned from selling each unit of product is the same.
Total contribution can therefore be calculates as: Units of sale × Contribution per
unit.
Example
A company manufactures and sells two products, A and B. Product A has a variable
cost of $6 and sells for $10, and product B has a variable cost of $8 and sells for $15.
During the period, 20,000 units of Product A and 30,000 units of Product B were
sold. Fixed costs were $260,000. What was the profit or loss for the period?
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Answer
Contribution per unit:
Product A: $10 – $6 = $4
Product B: $15 – $8 = $7
$
Contribution from Product A: (20,000 × $4)
80,000
Contribution from Product B: (30,000 × $7)
210,000
Total contribution for the period 290,000
Fixed costs for the period (260,000)
Profit for the period 30,000
Exercise 1
An entity sells two products, X and Y. Product X sells for $8 per unit and has a
variable cost of $3. Product Y sells for $6 per unit and has a variable cost of $2. Fixed
costs each month are $250,000.
Monthly sales are 40,000 units of Product X and 30,000 units of Product Y. There is
no inventory of either product.
Required
Using marginal costing, calculate the profit for the month.
2.2 A marginal costing income statement with opening and closing
inventory
The explanation of marginal costing has so far ignored opening and closing
inventory.
In absorption costing, the production cost of sales is calculated as ‘opening
inventory value + production costs incurred in the period – closing inventory
value’.
The same principle applies in marginal costing. The variable production cost of sales
is calculated as ‘opening inventory value + ‘opening inventory value + variable
production costs incurred in the period – closing inventory value’.
When marginal costing is used, inventory is valued at its marginal cost of
production (= variable production cost), without any absorbed fixed production
overheads.
Chapter 8: Marginal costing and absorption costing
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If an income statement is prepared using marginal costing, the opening and closing
inventory might be shown, as follows:
Income statement for the period ended [date]
$ $
Sales 440,000
Opening inventory at variable production cost 5,000
Variable production costs
Direct materials 60,000
Direct labour 30,000
Variable production overheads 15,000
110,000
Less: Closing inventory at variable production cost (8,000)
Variable production cost of sales 102,000
Variable selling and distribution costs 18,000
Variable cost of sales 120,000
Contribution 320,000
Fixed costs:
Production fixed costs 120,000
Administration costs (usually 100% fixed costs) 70,000
Selling and distribution fixed costs 90,000
Total fixed costs 280,000
Profit 40,000
However, when the variable production cost per unit is a constant amount, there is
no need to show the opening and closing inventory valuations, and the income
statement could be presented more simply as follows:
Income statement for the period ended [date]
$ $
Sales 440,000
Variable production cost of sales 102,000
Variable selling and distribution costs 18,000
Variable cost of sales 120,000
Total contribution
320,000
Fixed costs:
Production fixed costs 120,000
Administration costs 70,000
Selling and distribution fixed costs 90,000
Total fixed costs
280,000
Profit 40,000
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Marginal costing and absorption costing compared
Reporting profit with absorption costing
The difference in profit between marginal costing and absorption costing
Calculating the difference in profit: increase in inventory during a period
Calculating the difference in profit: reduction in inventory during a period
Summary: comparing marginal and absorption costing profit
3 Marginal costing and absorption costing compared
3.1 Reporting profit with absorption costing
Absorption costing is the ‘traditional’ way of measuring profit in a manufacturing
company. Inventory is valued at the full cost of production, which consists of direct
materials and direct labour cost plus absorbed production overheads (fixed and
variable production overheads).
The absorption rate for variable production overheads should be the same as the
variable overhead rate of expenditure. However in absorption costing variable and
fixed production overheads might not be separated.
In absorption costing, there is some under- or over-absorbed overhead, which
occurs because the absorption rate is a predetermined rate.
The full presentation of an absorption costing income statement might therefore be
as follows (illustrative figures included):
Income statement for the period ended [date]
$ $
Sales 430,000
Opening inventory at full production cost 8,000
Production costs
Direct materials 60,000
Direct labour 30,000
Production overheads absorbed 100,000
198,000
Less: Closing inventory at full production cost (14,000)
Full production cost of sales 184,000
246,000
Production overheads absorbed 100,000
Production overheads incurred 95,000
Over-absorbed overheads 5,000
251,000
Administration costs 70,000
Selling and distribution costs (fixed + variable) 108,000
178,000
Profit 73,000