Marginal Costing NJoy Toys Plc - Assignment Example

Marginal Costing vs. Absorption Costing NJoy Toys Plc case assignment Part I – Profit ments for 2 quarters based on marginal costing andabsorption costing a) The marginal cost of production per toy is worked out in the table below as £ 6.90 made up of the raw material, labour and the variable production overhead. The variable selling overhead is not part of the product cost. ( in £ )     Production costs of toys     Raw material 2.40   Labour 3.00   Variable production overhead 1.50   Marginal cost per toy 6.90         Overhead allocation in Absorption costing method Fixed production overhead 240,000   Production capacity per quarter 960,000   Overhead allocation per toy 0.25   Absorption cost per toy 7.15   b) In the absorption cost method, the fixed production overhead is apportioned based on the planned production capacity in the period. In the table above, the fixed production overhead of £ 240,000 is distributed over 960,000 toys and the allocation per toy is £ 0.25. This allocation, added to the marginal cost gives us the absorption cost per toy of £ 7.15. c) The production and sales quantities for the next two quarters and the resulting opening and closing stocks are shown below ( in numbers) Quarter 1 Quarter 2 Opening stock of toys 0 300,000 Production of toys 1,500,000 1,800,000 Sale of toys 1,200,000 1,350,000 Closing stock of toys 300,000 750,000 Profit calculation by the marginal costing method a) The sales revenue of £ 13.50 per toy is reduced by the variable sales overhead of £ 0.60 per toy and the fixed selling and administration cost for each quarter of £ 450,000 to arrive at the new sales realization for each quarter. ( in £ ) Quarter 1 Quarter 2 Sales Revenue @ £ 13.50 per toy 16,200,000 18,225,000 Variable sales overhead @ £ 0.60 per toy 720,000 810,000 Fixed selling & administration cost 450,000 450,000 Net sales realization 15,030,000 16,965,000 Marginal cost of production     Opening stock @ £ 6.90 marginal cost - 2,070,000 Cost of production @ £ 6.90 marginal cost 10,350,000 12,420,000 Closing stock @ £ 6.90 marginal cost 2,070,000 5,175,000 Marginal cost of production 8,280,000 9,315,000 Fixed production overhead 240,000 240,000 Total cost of production 8,520,000 9,555,000 Profit for the quarter marginal costing method 6,510,000 7,410,000 b) The marginal cost of production for each quarter is worked out at the marginal cost per toy of £ 6.90. The fixed production overhead of £ 240,000 is added to the marginal cost to arrive at the total cost of production. The profit for each quarter is the difference between the net sales realization and the production cost for each quarter. Profit calculation by the absorption costing method a) The net sales realization in the absorption costing method is the same as in the marginal costing method. b) The absorption cost of production for each quarter is worked out at the absorption cost of £ 7.15 per toy. The unadjusted profit for each quarter is the difference between the net sales realization and the total absorption cost of production. ( in £ ) Quarter 1 Quarter 2 Sales Revenue @ £ 13.50 per toy 16,200,000 18,225,000 Variable sales overhead @ £ 0.60 per toy 720,000 810,000 Fixed selling & administration cost 450,000 450,000 Net sales realization 15,030,000 16,965,000 Absorption cost of production     Opening stock @ £ 7.15 absorption cost - 2,145,000 Cost of production @ £ 7.15 absorption cost 10,725,000 12,870,000 Closing stock @ £ 7.15 absorption cost 2,145,000 5,362,500 Absorption cost of production 8,580,000 9,652,500 Unadjusted profit 6,450,000 7,312,500 Production overhead absorbed 375,000 450,000 Production overhead incurred 240,000 240,000 Over / (Under) absorption 135,000 210,000 Profit for the quarter absorption costing method 6,585,000 7,522,500 c) In the absorption method of costing, the fixed production overhead of £ 240,000 is already allocated to the product cost at £ 0.25 each assuming the quarterly production to be 960,000 toys. Since the actual production of toys in the two quarters are higher, there is an over absorption of the fixed production overhead. That difference is added to the unadjusted profit to arrive at the profit for the quarter. These profit figures are higher than the profit worked out by the marginal costing method as shown in the two tabulations. Reconciliation statement of the two methods of profit calculations  ( in £ )     Profit by marginal costing method 6,510,000 7,410,000 (Closing stock - opening stock of toys) nos 300,000 450,000 Production Overhead absorption of stock 75,000 112,500 Profit by absorption costing 6,585,000 7,522,500 The higher profit figure in the absorption costing method is due to the value of the production overhead assigned to the stock at the end of each quarter. Part II – Similarities and differences between the two methods of costing and the situations where they might be useful In general, absorption costing is used for all financial statements for external purposes and marginal costing is used for internal decision making, especially short-term (Hoare, R., 2011) Marginal costing is simple to use for manufacturing or operational staff as there is no apportionment of fixed costs. Marginal costing will show a constant net profit even when production fluctuates whereas with absorption costing profits will vary depending on production volumes (Steven, G., 2004). In marginal costing, fixed costs are period based and not related to level of production activity. There is, therefore, no over recovery or under recovery of fixed costs due to variations in activity level. Marginal costs will be misleading if used for cost plus pricing as the marginal cost does not take into account the total cost of the product. Absorption costs give a fairer picture of the product cost for pricing decisions (Hafeez, R.M., 2012). Absorption costing leads to apportioning of fixed costs to items in stock. This causes distortions in profitability reporting (Business Teacher, 2012). When more than one product is manufactured, apportionment of fixed costs between different product lines could be difficult. If the product mix changes month to month, any mistake in apportionment could lead to significant mistakes in profitability reporting. Marginal costing may be better suited for such cases (Hoque, Z., 2005). The recommendation to NJoy Toys plc is to continue using for at least the next two quarters since the production and sales volumes are so different from the planned capacity. During the next two quarters the company will be able to assess if the capacity needs to be augmented and that may need additional fixed costs. References: 1. Business Teacher, (2012). “Incurred production - an economic product”, Business Teacher, 2012. (Accessed on 10 Jan 2013 at www.businessteacher.co.uk) 2. Hafeez, R.M., (2012). “Managerial Accounting – Absorption, Variable & Throughput costing”, Hafeezrm hubpages, 8 Feb 2012. (Accessed on 10 Jan 2013 at www.hafeezrm.hubpages.com) 3. Hoare, R., (2011). “Absorption Costing Vs. Marginal Costing”, CPA Ireland, 2011. (Accessed on 10 Jan 2013 at www.cpaireland.ie) 4. Hoque, Z., (2005). “Handbook of Cost and Management Accounting”, Spiramus Press, 2005. (Accessed on 10 Jan 2013 at www.booksgoogle.co. uk) 5. Steven, G., (2004). “Absorption cost and marginal cost approaches to variance analysis”, CIMA, April 2004. (Accessed on 10 Jan 2013 at www.cimaglobal.com). Read More