Management Accounting

BBAP2103
Chapter 2 :
Marginal Costing and
Absorption Costing
 Foreword
Two types of costing system
Traditional : Consist of marginal costing and
absorption costing
Modern : Based on activity is grouped as a
modern costing system
 Absorption Costing
All fixed cost and variable cost considered as
product cost Direct material, direct labor and
manufacturing overhead
Also known as fully absorp manufacturing
costs
Important of absorption costing
External reporting
GAAP requirement : COGS value will
reported on income statement and ending
inventory value recorded on balance sheet
 Marginal Costing
Also known as variable costing or direct
costing
Only considered direct material, direct
labor and variable manufacturing
overhead to determine product cost
Fixed manufacturing overhead consider
as period cost because didnt involved
directly in production.
Ex : Sales and administration cost
 Marginal Costing (cont.)
Important of Marginal Costing
For internal reporting
Used in planning and decision making
process
The manager can control the product cost
because the variable cost put within their
control
 Marginal Costing (cont.)

Absorption Marginal
Costing Costing
Direct Material

Direct Labor Product

Product Cost
Cost Variable Manufacturing Overhead

Fixed Manufacturing Overhead

Period Variable Selling & Admin Expenses Period

Cost Cost
Fixed Selling & Admin Expenses
Different of Absorption Costing and
Marginal Costing
Different Between Absorption Costing & Marginal Costing
Aspects Absorption Costing Marginal Costing
Purpose External Internal
Format of Income Sales Sales
Statement - COGS - Variable Cost
= Gross Margin = Contribution Margin
- Operating Expenses - Fixed Cost
= Net Income = Net Income
Product Cost All manufacturing overhead Variable manufacturing
costs overhead costs
Period Cost All sales and administration All sales and administration
costs expenses
Fixed manufacturing
overhead cost
Different of Absorption Costing and
Marginal Costing (cont.)
Absorption Costing
Product cost : consist of direct material, direct labor
and manufacturing overhead cost
The product sold considered as COGS and product
unsold will recorded as inventory on balance sheet
Marginal Costing
Product cost : consist of direct material, direct labor
and variable manufacturing overhead cost
Fixed manufacturing overhead cost consider as
Period Cost
 Calculating of Product Cost Per
Unit
Question 1
Direct material RM 22 per unit
Direct labor RM14 per unit
Variable manufacturing overhead RM 6 per unit
Fixed manufacturing overhead RM 117,000 per year

2003 (unit) 2004 (unit)

Beginning inventory 0 3,000
Production 13,000 10,000
Sales 10,000 11,000
Ending inventory 3,000 2,000
 Calculating of Product Cost Per
Unit (cont.)
Selling price RM 75 per unit
Variable sales and administration RM 7 per unit
Fixed sales and administration RM 8,000 per year

Product cost based on Marginal Costing

2003 (RM) 2004 (RM)
Direct raw material 22.00 22.00
Direct labor 14.00 14.00
Variable manufacturing overhead 6.00 6.00
42.00 42.00
 Calculating of Product Cost Per
Unit (cont.)
Product cost based on Absorption Costing
2003 (RM) 2004 (RM)
Direct raw material 22.00 22.00
Direct labor 14.00 14.00
Variable manufacturing overhead 6.00 6.00
Fixed manufacturing overhead 9.00* 11.70**
51.00 53.70

Note * RM117,000/13,000 unit = RM9.00

** RM117,000/10,000 unit = RM11.70
 Calculating of Product Cost Per
Unit (cont.)
Question 2
Total production per year 6,000 unit
Variable cost per unit
Direct material RM 2
Direct labor RM 4
Manufacturing overhead RM 1
Selling and administration RM 3
Fixed cost per unit
Manufacturing overhead RM 30,000
Selling and administration RM 10,000
 Calculating of Product Cost Per
Unit (cont.)
Product cost based on Absorption Costing
Direct material RM 2
Direct labor RM 4
Manufacturing overhead RM 1
Fixed manufacturing overhead cost RM 5
RM30,000 / 6,000 unit)
Product cost RM 12
 Calculating of Product Cost Per
Unit (cont.)
Product cost based on Marginal Costing
Direct material RM 2
Direct labor RM 4
Manufacturing overhead RM 1
Product cost RM 7
 Calculating of Ending Inventory
Cost
Formula of ending inventory cost
= Quantity on ending inventory x
Product cost per unit
Ending inventory cost under Marginal Costing
= 3,000 unit x RM42 = RM126,000
Ending inventory cost under Marginal Costing
= 3,000 unit x RM51 = RM153,000
 Calculating of Ending Inventory
Cost (cont.)
Net income under Absorption Costing
higher that net income recorded under
Marginal Costing
Factor : Fixed manufacturing overhead
cost
 Income Statement Under Marginal
Costing for 2003
Revenue (10,000 x RM75) 750,000
(-) Variable Cost)
COGS :
Beginning Inventory 0
Manufacturing Cost (13,000 x RM42) 546,000
Cost of Good Available for Sale 546,000
(-) Ending Inventory (3,000 x RM42) (126,000)
420,000
(+) Variable Sales & Admin Cost (10,000 x RM7) 70,000 (490,000)

Contribution Margin 260,000

(-) Fixed Cost
Manufacturing Overhead 117,000
Sales and Administration 8,000 125,000
Net Income 135,000
 Income Statement Under
Absorption Costing for 2003
Revenue (10,000 x RM75) 750,000
COGS :
Beginning Inventory 0
Manufacturing Cost (13,000 x RM51) 663,000
Cost of Good Available for Sale 663,000
(-) Ending Inventory (3,000 x RM51) (153,000) (510,000)
Gross Profit 240,000
Fixed Sales and Administration 8,000
Variable Sales and Administration 70,000 78,000
Net Income 162,000
 Connection Between Production Unit,
Sales, Inventory Value and Net Income
Net income for both methods is different
because of two situation
When the production level exceed quantity
sold
When the quantity sold exceed production
level
Refer the Hafizuddin Berhad information
for 2002-2004 below:
 Variable cost per unit
Direct Material RM 3.00
Direct Labor RM 6.00
Manufacturing Overhead RM 1.00
Sales & Administration RM 2.00
Fixed cost per year
Manufacturing Overhead RM 60,000
Sales & Administration RM 10,000
 Production level, sales and inventory value in unit

2002 2003 2004

Beginning Inventory 0 1,000 1,000
Production 5,000 5,000 4,000
Sales 4,000 5,000 5,000
Ending Inventory 1,000 1,000 0

Selling price = RM 30.00 per unit

 Product cost per unit under Marginal Costing

2002 (RM) 2003 (RM) 2004 (RM)

Direct material 3.00 3.00 3.00
Direct labor 6.00 6.00 6.00
Variable
manufacturing 1.00 1.00 1.00
overhead
Product Cost 10.00 10.00 10.00
 Product cost per unit under Absorption Costing

2002 (RM) 2003 (RM) 2004 (RM)

Direct material 3.00 3.00 3.00
Direct labor 6.00 6.00 6.00
Variable
manufacturing 1.00 1.00 1.00
overhead
Fixed 60,000 / 60,000 / 60,000 /
manufacturing 5,000 5,000 4,000
overhead = RM12.00 = RM12.00 = RM15.00
Product Cost 22.00 22.00 25.00
 Income Statement under Marginal Costing
2002 (RM) 2003 (RM) 2004 (RM) Total (RM)
Revenue 120,000 150,000 150,000 420,000
COGS :
Beginning inventory 0 10,000 10,000 20,000
(+) Manufacturing cost 50,000 50,000 40,000 140,000
Cost of good available for sale 50,000 60,000 50,000 160,000
(-) Ending inventory (10,000) (10,000) 0 (20,000)
40,000 50,000 50,000 140,000

Contribution Margin 80,000 100,000 100,000 280,000

(-) Variable cost for Selling and
Administration (8,000) (10,000) (10,000) (28,000)
Profit Margin 72,000 90,000 90,000 252,000
(-) Fixed cost
Manufacturing overhead 60,000 60,000 60,000 180,000
Selling and Administration 10,000 10,000 10,000 30,000
70,000 70,000 70,000 210,000
Net Profit 2,000 20,000 20,000 42,000
 Income Statement under Absorption Costing
2002 (RM) 2003 (RM) 2004 (RM) Total (RM)
Revenue 120,000 150,000 150,000 420,000
COGS :
Beginning inventory 0 22,000 22,000 44,000
(+) Manufacturing cost 110,000 110,000 100,000 320,000
Cost of good available for sale 110,000 132,000 122,000 364,000
(-) Ending inventory (22,000) (22,000) 0 (44,000)
88,000 110,000 122,000 320,000

Gross Profit 32,000 40,000 28,000 100,000

(-) Selling and Administration
Variable cost 8,000 10,000 10,000 28,000
Fixed cost 10,000 10,000 10,000 30,000
18,000 20,000 20,000 58,000
Net Profit 14,000 20,000 8,000 42,000
 Summary of income statement
2002 : Net profit for AC more than MC
2003 : Net profit AC = MC
2004 : Net profit AC less than MC

Production level > Quantity sold Net Profit AC > MC

Production level = Quantity sold Net Profit AC = MC
Production level < Quantity sold Net Profit AC < MC
 Evaluation of Method
Marginal Costing
Advantages
Suitable for performance measurement and cost
analysis
Consist of relevant information for planning,
controlling and decision making purposes
Price more effectively
Disadvantages
Usage for internal management only
Reports didnt follow GAAP format
 Evaluation of Method (cont.)
Absorption Costing
Advantages
Used on a wider scale compared to Marginal
Costing for external reporting
Only prepared 1 report reduce cost
Disadvantages
Not necessary to measured performance and cost
analysis because consist fixed cost that not
relevant in decision making