Babita ABC Final

8/13/2019 Babita ABC Final

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Accounting for decision making

ECTURER-TR CY

SUBMITTED BY-BABITA KC

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Table of contents

Page no.

Task 1 3

Task 2 5

Task 3 9

Task4 12

Reference 14

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To: The Divisional Manager

Fro: Manageent !cco"ntant

Date: 15th of March# 2$13.

Ref: %ost Manageent !cco"nting re&ort

Task 1

Under absorption costing, cost of goods sold and ending inventory consist only of factory

overhead. On the other hand in marginal costing there are no further cost to a central cost of

goods sold on inventory is because there are no variable cost of production.

However in July the absorption costing profit of 41, various marginal costing result in

profit of !. On the other hand during the month of "ugust the profit for absorption costing

was # and marginal costing was $. %he &ey to understanding the effect of findings in

inventories lies in the accounting for fi'ed factory overhead. Under marginal costing the

income statement each period includes the fi'ed manufacturing overhead actually incurred

that period. Under absorption costing the situation is more complicated than income

statement (the fi'ed manufacturing cost which is part of standard cost of household . )n this

stage the difference between profit reported under absorption costing and marginal costing isalways e*ual to the difference in the amount of fi'ed manufacturing overhead charged in

income statement. +hen the undoing the month of "ugust and the production staff s where in

holiday. )n this stage due to lac& of wor&force there were production. )n addition it is also

observed that no reduction in production staff resulted in production overhead being under

absorbed and this is # under a result of overheads that result in additional fi'ed overhead

compared with July been assigned as cost with the "ugust profit statement.

ut as "ugust being a holiday period, there was short of the staff in production department

which resulted in less production, this situation incurred to production overheads being under

absorbed and resulted in additional fi'ed overheads. %his is shown in above calculation as the

fi'ed overhead volume variance for "ugust is #, which is under-absorption of overhead.

"nd so the fi'ed production costs included in absorption costing profit statement reached to

14 after adding the fi'ed production costs incorporated on cost of goods sold for the

month of "ugust.

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July /s0 "ugust

/s0

%ost of sales 'absor&tion costing( 3$$$ 33$$

%ost of sales 'variable)arginal costing( ! !!

Fi*e+ &ro+"ction costs incor&orate+ in cost of goo+s

sales

1 11

Fi*e+ overhea+ vol"e variance 10 #

Fi*e+ &ro+"ction costs incl"+e+ in absor&tion costing&rofit stateent

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Fi*e+ &ro+"ction costs incl"+e+ in arginal costing

&rofit stateent

1! 1!

Difference bet,een arginal costing an+ absor&tion

costing fi*e+ costs

!10 !

Reconciliation of the +ifference bet,een absor&tion an+ arginal costing &rofits2

Marginal costing &rofit 2$$ 5$$

!bsor&tion costing &rofit 41

!1

#

!

-*hibit 1: Manageent !cco"nting &rofitabilit analsis.

Task T,o

%oent on the vario"s stateent &rovi+e+ b the anageent an+ their i&lication

for anageent acco"nting.

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Statement One: He stated that surely if there is a significant increase in sales this should

be reflected in an increase in profits.

%he researcher strongly agrees with the mentioned statement. %o avoid mista&es when

absorption costing is used for readers of financial statements it gives attention to both fi'ed

and variable costs3 that is, all production costs are considered regardless of whether they are

variable or fi'ed. "nd, this is very important when it comes to pricing decisions since the

manufacturer can have a clear picture of the profit margin to be made on each sale, as all

costs would have been incorporated into the product cost. Under absorption costing, if

inventories increase, fi'ed manufacturing overhead costs are deferred in inventories, which

in turn increases net operating income. )f inventories decrease, fi'ed manufacturing overhead

costs are released from an inventory, which in turn decreases net operating income.

Statement Two: He pointed out that the process was time consuming and many of these

allocations were arbitrary and had the potential to distort the profit margin on individual

products.

%he researcher strongly agrees with the mentioned statement. %he marginal cost distinguishes

between fi'ed and variable costs therefore providing relevant information about costs for

decision ma&ing purposes. +hen fi'ed and variable costs are split, it becomes easier to

manage costs as it gets clearer to management on how costs behave. o, by altering the

activity level, for instance, management an choose an optimal production level.5emoves the

effect of inventory changes on profit and reduces the danger of dysfunctional behaviour in

employees. 6ysfunctional behaviour may occur in the case of absorption costing by

encouraging managers to produce more inventory than can be sold. 7roducing for stoc& has

the effect of absorbing more fi'ed production overheads, hence reducing the cost of sale. %he

reduced cost of sale has the effect of improving the level of reported profits. However, it is

possible for such stoc& to tie up capital and even become obsolete. %his is dysfunctional.

Statement Three: She pointed out that with the marginal costing system that business

would be under taken at margins that exceeded the variable cost but they may not provide

a sufficient contribution to covering fixed cost or generating sufficient profit.

%he researcher strongly agrees with the mentioned statement. %he marginal 8ost of product isits variable cost. )t includes direct materials, direct labour, direct e'penses and the variable

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part of over heads. %he term marginal costing has been defined as the ascertainment of

marginal cost and the effect of profit or changes in volume or type of output by

differentiating between fi'ed costs and variable costs. ()n the techni*ue of costing only

variable cost and charges to cost units and fi'ed costs are to be written of against contribution

for that period contribution is nothing but the e'cess of sale price over marginal cost.

Statement our: Therefore it would be necessary to operate both marginal and absorption

costing systems!one for internal profit measurement and other for external profit

measurement.

%he researcher strongly agrees with the mentioned statement.

Marginal costing for e*ternal &rofit

1. 8ost 8lassification2 %he marginal costing techni*ue ma&es a sharp distinction between

variable costs and fi'ed costs. )t is the variable cost on the basis of which production and

sales policies are designed by a firm following the marginal costing techni*ue.

!. toc&9)nventory :aluation2 Under marginal costing, inventory9stoc& for profit

measurement is valued at marginal cost. )t is in sharp contrast to the total unit cost under

absorption costing method.

#. ;arginal 8ontribution2 ;arginal costing techni*ue ma&es use of marginal contribution for

mar&ing various decisions. ;arginal contribution is the difference between sales and

marginal cost. )t forms the basis for


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produced must include a share of all production costs, both fi'ed and variable, incurred in

getting them to their present condition arrett,!$0.

%he difference between the profit figures calculated under absorption and marginal costing

principles is caused by the treatment of fi'ed production overheads. )n marginal costing the

full amount of fi'ed production overheads is written off in the period that it occurs. )n

absorption part of the fi'ed production overheads is carried between

accounting periods as part of inventory valuations.

Statement ive: She suggested an activity based costing system as an alternative method

for costing that could be considered.

"ctivity based costing "80 is a managerial accounting system that estimates the cost of

products and services by assigning overhead costs to direct costs. %his costing method

assigns the cost of each activity in an organi=ation to all products and services according to

the actual consumption of the activity resource by the product or service. %his is a mar&ed

departure from the practice of sharing overheads costs e*ually or overheads becoming part of

the overall profit-loss estimate instead of component product pricing. )n contrast to traditional

cost accounting systems, "8 systems first accumulate overheads for each organisational

activity. %hey then assign the costs of these activities to products, services or customers

referred to as cost ob


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Task 3

!bsor&tion costing2 )n absorption costing system the >'ed production costs for a period are

shared across the output for that period. %herefore, a product/s costs will consist of its

variable costs, direct materials, direct labour, and variable direct0 production overheads0

plus a share of >'ed production overheads. 8losing stoc&s and wor& in progress will8


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therefore include a share of the current period/s overheads. "s a result, some of the current

period/s >'ed costs will be carried into the ne't period/s production cost of sales .

Marginal costing: )n marginal costing system a product/s production cost is its variable

production cost. %herefore, any unsold production, i.e. closing stoc&s or wor& in progress,

will also be valued at its variable production cost. 8ontribution will be revenue less the

variable cost of sales. %he variable cost of sales is the variable production cost of the goods or

services sold in a period plus any variable selling and distribution costs."ll the >'ed costs for

a period will be charged to that period/s pro>t and loss account

!rg"ents in favo"r of absor&tion costing

a0 ?i'ed production costs are incurred in order to ma&e output3 it is therefore @fair@ to charge

all output with a share of these costs.

b0 8losing inventory values, include a share of fi'ed production overhead, and therefore

follow the re*uirements of the international accounting standard on inventory valuation '/!0

/nternational !cco"nting stan+ar+s 2(.

c0 "bsorption costing is consistent with the accruals concept as a proportion of the costs of

production are carried forward to be matched against future sales.

d0 " problem with calculating the contribution of various products made by an enterprise is

that it may not be clear whether the contribution earned by each product is enough to cover

fi'ed costs, whereas by charging fi'ed overhead to a product it is possible to ascertain

whether it is profitable or not.

%his is particularly important where fi'ed production overheads are a large proportion of

total production costs. Aot absorbing production would mean that a large portion of

e'penditure is not accounted for in unit costs.

!rg"ents in favo"r of arginal costing

a0 )t is simple to operate.

b0 %here are no apportionments, which are fre*uently done on an arbitrary basis, of fi'ed

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costs. ;any costs, such as the mar&eting director@s salary, are indivisible by nature.

c0 ?i'ed costs will be the same regardless of the volume of output, because they are period

costs. )t ma&es sense, therefore, to charge them in full as a cost to the period.

d0 %he cost to produce an e'tra unit is the variable production cost. )t is realistic to value

closing inventory items at this directly attributable cost.

e0 Under or over absorption of overheads is avoided.

f0 ;arginal costing provides the best information for decision ma&ing.

g0 ?i'ed costs such as depreciation, rent and salaries0 relate to a period of time and should

be charged against the revenues of the period in which they are incurred.

h0 "bsorption costing may encourage over-production since reported profits can be

increased by increasing inventory levels.

FR!RD

)f there are changes in inventories during a period, marginal costing and absorption costing

systems will report different profit figures. )f inventory levels increase, absorption costingwill report a higher profit than marginal costing. %his is because some of the fi'ed production

overhead incurred during the period will be carried forward in closing inventory which

reduces cost of sales0 to be set against sales revenue in the following period instead of being

written off in full against profit in the period concerned. )f inventory levels decrease,

absorption costing will report the lower profit. %his is because as well as the fi'ed overhead

incurred, fi'ed production overhead which had been brought forward in opening inventory is

released and is included in cost of sales. )f the opening and closing inventory volumes and

values are the same, marginal costing and absorption costing will report the same profit

figure. )t is important to appreciate that the differences in reported profits occur only in the

short run, in this stage in reporting the profit of individual accounting periods. )n the long

run, the total reported profit will be the same whether marginal or absorption costing is used.

%his is because in the long run, total costs will be the same by either method of accounting.

hort term differences are the result of changes in the level of inventory)"llot,!40.

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Recoen+ation

)n spite of the arguments in favour of marginal costing as a decision ma&ing tool, absorption

costing is widely used for general accounting purposes and inventory valuation. ?i'ed

production costs should ultimately be charged to cost units in a fair and meaningful way. "

central problem in cost accounting is to identify the best method of attributing these costs.

)n the following few chapters we shall loo& at new approaches developed to address the

wea&nesses of both marginal and absorption costing.

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"ctivity based costing, however, faces serious challenges in practical application, for

appropriating some of the fi'ed overheads such as the chief e'ecutive@s salary on a per-

product usage basis, is ne't to impossible. ;oreover, process of data collection, data entry,

anddata analysis re*uiredto divide the fi'ed overhead costs among units based on usage,

re*uires substantial resources and remains costly to maintain. "bsorption costing that divides

all fi'ed overhead costs with the number of units produced is a simple and easy approach and

free from such comple'ities.

Eegal :alidity

"bsorption costing complies with the generally accepted accounting principlesF""70

whereas the ?inancial "ccounting tandards oard ?"0 and )nternal 5evenue ervice

)50 do not accept "8 for e'ternally published financial statements. ?irms that follow

activity based costing, therefore, need to maintain two cost systems and accounting boo&s,

one for internal use, and another for e'ternal reports, filings, and statutory compliance.

Difference in 0co&e

"bsorption costing helps ascertain the overall profitability or efficiency of the manufacturing

system but fails to provide the real cost of individual product units.

"ctivity based costing mirrors the functioning of theenterpriseand contributes to strategic

decision-ma&ing processes. "8 provides the real cost of individual product units and,

thereby, helps identify inefficient or non-profitable products that eat into the profitability of

other highly profitable products. "8 also helps price products e*uitably, allowing brea&ing

down of product or service into sub-components or offering Gtop ups based on customer

needsHung,!110.

8omparing absorption costing vs activity based costing, activity based costing improves the

*uality of managementaccounting information, especially in large and multi-product

operations where conventional overhead allocation methods such as absorption costing may

produce misleading results. "bsorption costing, however, remains more suitable for small

firms and enterprises with homogeneous products or services.

Reference

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http://www.brighthub.com/computing/windows-platform/articles/45031.aspxhttp://www.brighthub.com/office/finance/articles/18891.aspxhttp://www.brighthub.com/office/finance/articles/86649.aspxhttp://www.brighthub.com/office/finance/articles/86649.aspxhttp://www.brighthub.com/office/finance/articles/86649.aspxhttp://www.brighthub.com/computing/windows-platform/articles/45031.aspxhttp://www.brighthub.com/office/finance/articles/18891.aspxhttp://www.brighthub.com/office/finance/articles/86649.aspxhttp://www.brighthub.com/office/finance/articles/86649.aspx


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"llott, "!40. "ctivity ased ;anagement can wor& for your company. 8);" )nsight,

"vailable from2 www.cimaglobal.com9insightI"ccessed 4th;arch !1#.

arrett, 5.!$0 How "8 can ma&e shared services wor&. 8);" )nsight,

"vailable from2 www.cimaglobal.com9insightI"ccessed !nd;arch !1#.

6rury,8.!D0 ;anagement and 8ost "ccounting, Kth Ldition, outh-+estern

Hung,8.!110, ""% 7aper # ;anagement "ccounting, ?irst Ldition, 7rentice

Hall

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