Walk talk manufacture a cordless telephone system . At the beginning of the financial year ending 30 Nov 2009 , the firm budgeted to make and sell 50,000 units of its only product , the NOVA at the selling price of 30 $ per unit . other budgeted information is as follows :
Direct martial $4.00 per unit Direct labour $6.00 per unit
fixes production overhead for the year were budgeted at $800,000 to be absorbed on the basis of the number of units product . fixed selling and administration expenses were estimated at $100,000 to be absorbed on the basis of the number of units sold .
At the beginning of the year ( 1 Dec 2008 ) there were no units in inventory and no units were budgeted to be in inventory at end of the year ( 30 Nov 2009 ) .
situation at 1 Dec 2009 .
the market of cordless phone has changed rapidly over the course of one year . In response to competitive pressure, company had to make number of changes in NOVA model and range of colours available . there are now three different versions of NOVA and eight different colours.
During the year cost of direct martial and direct labour per unit have been incurred in line with budgeted cost above. Fixed production overhead have risen to $830,000 , due to the higher than expected rent review for factory. Selling and distribution costs were budgeted.
production has increased to $ 52,000 units, however despite of chance of product specification sales have only reached to $45,000 units.
Required :
a) prepare the income statement for the year ended 30 Nov 2010 using the following two methods.
1- absorption costing
2- marginal costing
b) compare the profits of absorption and marginal costing calculated above and explain the reasons for any differences.
To prepare the income statement for the year ended 30 Nov 2010 using absorption costing and marginal costing, we need to calculate the total costs and revenues for each method separately.
a) Income statement using absorption costing:
Under absorption costing, all manufacturing costs (both variable and fixed) are assigned to units of the product. This includes direct martial, direct labor, and fixed production overhead.
1. Calculate the variable costs:
Variable cost per unit = Direct martial + Direct labor
Variable cost per unit = $4.00 + $6.00 = $10.00
Total variable cost = Variable cost per unit x Number of units produced
Total variable cost = $10.00 x 52,000 = $520,000
2. Calculate the fixed production overhead:
Fixed production overhead = $830,000
3. Calculate the total manufacturing cost:
Total manufacturing cost = Total variable cost + Fixed production overhead
Total manufacturing cost = $520,000 + $830,000 = $1,350,000
4. Calculate the cost of goods sold:
Cost of goods sold = Total manufacturing cost
Cost of goods sold = $1,350,000
5. Calculate the gross profit:
Gross profit = Sales - Cost of goods sold
Gross profit = (Number of units sold x Selling price) - Cost of goods sold
Gross profit = (45,000 x $30) - $1,350,000
Gross profit = $1,350,000
6. Calculate the operating expenses:
Operating expenses = Fixed selling and administration expenses
Operating expenses = $100,000
7. Calculate the net profit:
Net profit = Gross profit - Operating expenses
Net profit = $1,350,000 - $100,000
Net profit = $1,250,000
b) Income statement using marginal costing:
Under marginal costing, only the variable costs (direct martial and direct labor) are assigned to units of the product. Fixed production overhead is treated as a period cost and not included in the cost of goods sold.
1. Calculate the variable costs (same as earlier):
Variable cost per unit = $10.00
Total variable cost = $520,000
2. Calculate the cost of goods sold:
Cost of goods sold = Total variable cost
Cost of goods sold = $520,000
3. Calculate the gross profit:
Gross profit = Sales - Cost of goods sold
Gross profit = (Number of units sold x Selling price) - Cost of goods sold
Gross profit = (45,000 x $30) - $520,000
Gross profit = $730,000
4. Calculate the operating expenses (same as earlier):
Operating expenses = Fixed selling and administration expenses
Operating expenses = $100,000
5. Calculate the net profit:
Net profit = Gross profit - Operating expenses
Net profit = $730,000 - $100,000
Net profit = $630,000
b) Comparison of profits:
Absorption costing net profit = $1,250,000
Marginal costing net profit = $630,000
There is a significant difference in profits between absorption costing and marginal costing. The main reason for this difference is the treatment of fixed production overhead costs. In absorption costing, these costs are allocated to the cost of goods sold, leading to a higher cost of goods sold and lower net profit. In marginal costing, fixed production overhead costs are treated as a period cost and not included in the cost of goods sold, resulting in a higher net profit.
This difference arises because absorption costing spreads fixed overhead costs across all units produced, regardless of whether they are sold or not. On the other hand, marginal costing only considers the costs directly related to the units sold.
In this case, the lower net profit under absorption costing is due to the higher number of units produced (52,000) compared to the number of units sold (45,000). As a result, more fixed overhead costs are allocated to the cost of goods sold, reducing the net profit. Marginal costing, on the other hand, focuses only on the variable costs directly related to the units sold, resulting in a higher net profit.