Costing 1

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Costing

1

Income statement using absorption costing

2013

2014

Unit Sales (A)

50000

48000

Unit Selling price (B)

15

14

Sales Revenue =C= A*B

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp 750,000.00

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp &nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp672,000.00

Less: Variable manufacturing cost = A*10

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp (500,000.00)

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp (480,000.00)

Gross Margin

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp 250,000.00

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp 192,000.00

Less: Fixed manufacturing cost

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp (175,000.00)

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp (105,000.00)

(175000 /50000)*50000

(175000 /80000)*48000

Net Profit

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp 75,000.00

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp 87,000.00

2

Income statement using Variable costing

2013

2014

Unit Sales (A)

50000

48000

Unit Selling price (B)

15

14

Sales Revenue =C= A*B

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp 750,000.00

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp 672,000.00

Less: Variable manufacturing cost = A*10

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp (500,000.00)

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp (480,000.00)

Contribution Margin

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp 250,000.00

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp 192,000.00

Less: Fixed manufacturing cost

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp (175,000.00)

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp (175,000.00)

(175000 /50000)*50000

(175000 /80000)*48000

Net Profit

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp 75,000.00

$&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp&nbsp 17,000.00

Absorptionand Variable Costing

Variable(direct) and absorption (full) costing are used in the application ofproduction expenses to services or products. The main differencebetween these two techniques arises in the treatment of fixedmanufacturing overhead costs. According to Walker (2006), under thedirect method, all the precise assembling fees are expensed duringthe period in which they were incurred. On the other hand, fullcosting, all the fixed production costs are expensed when a productis sold.

Absorptioncosting differs from variable costing in that under the former, alldirect expenses and the variable and fixed manufacturing overheadcosts are applied to the end product. Nigam and Jain (2001), positsthat under absorption costing, all these outlays are carried by theproduct through the inventory accounts up to the point they are sold.At this point these charges are therefore expensed as prices of goodssold on the income statement.

Onthe other hand, under variable costing, all the direct costs and thevariable overhead manufacturing costs are applied to the end product.Walker (2006), notes that up and until the product is sold, thesecosts move with a product throughout the inventory accounts. At thetime of sale, these costs are expensed as cost of goods sold on theincome statement. Additionally, the fixed manufacturing overheadcosts are also expensed during the period they have been incurred.

Inour scenario, while computing the unit product cost under absorptioncosting will be equal to $13.5 which is computed as:

Variablemanufacturing cost = $10

Fixedmanufacturing overhead=175000/50,000 = $3.5

[Fixedcosts divided by the total units produced]

Unitproduct cost = $13.5.

However,under variable costing, the unit product cost = $10. The fixedmanufacturing overhead cost is omitted while calculating the unitcost under the direct costing.

Whereassome accountants in favor of absorption costing while others argue infavor of variable costing, the former method is regarded as a moreaccurate reflection of a company’s financial situation. Underabsorption costing, the fixed production costs are incurred in theprocess of making the outputs and it is therefore fair if a share ofthe fixed costs were charged to such output (Chadwick, 1999).Additionally, absorption costing is more accurate in that the closingstock values also includes a share of fixed production overheads thatis advocated for by the standard accounting practice on stockvaluation.

Finally,absorption costing method enables the firm to ascertain if aparticular unit of production is profitable or not. In thecalculation of the contribution for the various products, theorganization may not be able to know whether the contribution arisingfrom the products is enough to cover the fixed costs. However, byapportioning a portion of the fixed costs to each unit of production,the firm can ascertain its profitability. This makes absorptioncosting method to be preferred in profit reporting and in preparationof the financial reports.

References

Chadwick,L. (1999).&nbspManagementaccounting.London: Internat. Thomson Business Press.

Nigam,B. M. L., &amp Jain, I. C. (2001).&nbspCostaccounting: An introduction.New Delhi, India: Prentice-Hall of India.

Walker,J. (2006).&nbspCIMAstudy systems: Management accounting fundamentals (CIMA study system: certificate level S).Oxford, UK: CIMA Publishing.

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