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11 Chapter 3 the mAnAgement ACCountAnts Profit stAtement – mArginAl Costing 1 Overview This is the third of three chapters revising some of the costing that you studied for Paper F2. Some businesses only want to know the variable cost of the units they make, regarding fixed costs as period costs. The variable cost is the extra cost each time a unit is made, fixed costs being effectively incurred before any production is started. The variable production cost of a unit is made up of: Direct materials Direct labour Variable production overheads Marginal cost of a unit Marginal costing Variable production costs are included in cost per unit (i.e. treated as a product cost). Fixed costs are deducted as a period cost in the Profit Statement. $ X X X X 2 Contribution Contribution is an important concept in marginal costing. Contribution is an abbreviation of “contribution towards fixed costs and profit”. It is the difference between selling price and all variable costs (including non-production variable costs), usually expressed on a per unit basis. Selling price: Less: Variable production costs Contribution $ X X $ X (X) X Variable non-production costs Note: Contribution takes account of all variable costs. Marginal cost takes account of variable production costs only and stock is valued at marginal cost. 12 ExamplE 1 X plc produces one product – desks. Each desk is budgeted to require 4kg of wood at $3 per kg, 4 hours of labour at $2 per hour, and variable production overheads of $5 per unit. Fixed production overheads are budgeted at $20,000 per month and average production is estimated to be 10,000 units per month. The selling price is fixed at $35 per unit. There is also a variable selling cost of $1 per unit and fixed selling cost of $2,000 per month. During the first two months, X plc expects the following levels of activity: Production Sales January 11,000 units 9,000 units February 9,500 units 11,500 units All other results were as budgeted. (a) (b) Prepare a cost card using marginal costing Set out Profit Statement for the months of January and February. The Management Accountants Profit Statement – Marginal Costing 13 Chapter 3 ExamplE 2 Prepare a reconciliation of absorption and marginal costing profits January $ February $ Absorption costing Marginal costing Difference The difference in profit arises from the different stock valuations which are the result of the difference in treatment of the fixed production overheads. Effects The delay in charging some production overheads under absorption costing leads to the following situations. ExamplE 3 Required Compare profits under marginal and absorption costing for the following situations (a) Production > Sales (b) Production < Sales (c) Production = Sales 14 3 Advantages and disadvantages of marginal costing as compared to absorption costing Advantages More appropriate for decision-making when considering different levels of activity. Fixed costs are treated in accordance with their nature, i.e. as period costs. Profit depends on sales as opposed to production activity levels and is hence more appropriate for performance evaluation. Disadvantages Does not comply with IAS 2. Costs must be analysed into fixed and variable parts. Fixed costs cannot be ignored in the long-run.