Required:
a. Reconcile the profit figures earned under Absorption Costing and Marginal Costing in quarter 2
b. Reconcile the profit figures earned under Absorption Costing and Marginal Costing in quarter
c. Describe the reason(s) of profit behavior under Absorption Costing and Marginal Costing in quarter 1,2
and 3.
SOLUTION:
a. Reconciliation of profit figures in quarter 2:
Under Absorption Costing:
Profit = Sales - (Opening Inventory + Production Costs + Period Expenses) = 48,000 - (0 + 180,000 + 20,000) = 48,000 - 200,000 = -152,000
Under Marginal Costing:
Profit = Sales - Variable Costs - Period Expenses = 44,000 - (160,000 + 20,000) = 44,000 - 180,000 = -136,000
The reconciliation shows that under both Absorption Costing and Marginal Costing, the company incurred a loss in quarter 2. However, the loss under Absorption Costing is higher compared to Marginal Costing. This difference can be attributed to the treatment of fixed manufacturing overhead costs.
b. Reconciliation of profit figures in quarter 3:
Under Absorption Costing:
Profit = Sales - (Opening Inventory + Production Costs + Period Expenses) = 66,000 - (0 + 180,000 + 20,000) = 66,000 - 200,000 = -134,000
Under Marginal Costing:
Profit = Sales - Variable Costs - Period Expenses = 68,000 - (160,000 + 20,000) = 68,000 - 180,000 = -112,000
Similar to quarter 2, the company incurred a loss in quarter 3 under both Absorption Costing and Marginal Costing. However, the loss under Absorption Costing is higher compared to Marginal Costing due to the treatment of fixed manufacturing overhead costs.
c. Reasons for profit behavior under Absorption Costing and Marginal Costing in quarter 1, 2, and 3:
Under Absorption Costing, fixed manufacturing overhead costs are allocated to each unit of production, including units in ending inventory. This means that the fixed manufacturing overhead costs are spread across the units sold and the units in inventory. As a result, when the number of units produced exceeds the number of units sold, the fixed manufacturing overhead costs per unit decrease, leading to a higher profit per unit.
In quarter 1, the company produced and sold 100 units, resulting in no ending inventory. Therefore, the profit figures are the same under both Absorption Costing and Marginal Costing.
In quarter 2, the company produced 100 units but only sold 80 units, leaving 20 units in ending inventory. The fixed manufacturing overhead costs associated with these 20 units are allocated to the units sold, reducing the profit per unit and resulting in a higher loss under Absorption Costing compared to Marginal Costing.
In quarter 3, the company produced 100 units and sold 110 units, creating a negative ending inventory balance. The fixed manufacturing overhead costs associated with the negative ending inventory are still allocated to the units sold, further reducing the profit per unit and resulting in a higher loss under Absorption Costing compared to Marginal Costing.
Therefore, the profit behavior under Absorption Costing and Marginal Costing differs due to the treatment of fixed manufacturing overhead costs and the allocation to ending inventory. Marginal Costing only considers variable costs in determining profit, whereas Absorption Costing includes fixed manufacturing overhead costs, which can result in different profit figures depending on the level of production and sales.
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