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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.aspx8/13/2019 Babita ABC Final
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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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