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Contribution
An important measure in marginal costing Is the difference between the sales value and the marginal or variable cost of sales Contribution may be defined as the profit before the recovery of fixed costs contribution goes toward the recovery of fixed cost and profit, and is equal to fixed cost plus profit (C = F + P). In case a firm neither makes profit nor suffers loss, contribution will be just equal to fixed cost (C = F). this is known as break even point.
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Profit
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Example
In a period 20,000 units of Z were produced and only 18,000 units were sold and 2,000 units were carried forward as stock to the next period. Costs and revenues were: $ Sales 100,000 Production Costs: Variable 35,000 Fixed 15,000 Administrative and selling overheads 25,000 Prepare profit statements based on marginal costing and on absorption costing.
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Activity
Marginal and absorption costing compared
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Reconciling profits
The difference in profits reported under the two costing systems is due to the different inventory valuation method used. If inventory levels increase between the beginning and the end of the period, absorption costing will report a higher profit. This is because some of the fixed production overhead incurred during the period will be carried forward in closing inventory (which reduces cost of sales) to be set against sales revenue in the following period instead of being written off in full against profit in the period concerned. If inventory levels decrease, absorption costing will report the lower profit.
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Example
Reconciliation of profit of ING Inc Marginal costing profit 26,640 To calculate absorption costing profit given a change in inventory level of 40,000 (280,000 240,000) and an overhead absorption rate of Rs 1.25
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Activity
The overhead absorption rate for product X is Rs 10 per machine hour. Each unit of product X requires five machine hours. Inventory of product X on 1 Jan was 150 units and on 31 Dec it was 100 units. What is the difference in profit between results reported using absorption costing and results reported using marginal costing.
Hint- Difference in profit = change in inventory * fixed overhead absorption per unit
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Activity
When opening inventories were 8,500 litres and closing inventories were 6,750 litres, a company had a profit of Rs 62,100 using marginal costing. Assume that the fixed overhead absorption rate was Rs 3 per litres, what would be the profit using absorption costing?
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Student activity
What are the advantages and disadvantages of marginal costing What are the advantages and disadvantages of absorption costing
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