HKDSE Sample 2 (Paper 2A, 2) (Absorption and Marginal Costing)

HKDSE Sample 2 (Paper 2A, 2) (Absorption and marginal Costing)

Perry Ltd started producing Product A on 1 January 2012. The unit selling price and cost of Product A for the month of January 2012 were as follows:

($/unit)
Selling price / 5.90
Direct material / 1.20
Direct labour / 1.40
Variable production overheads / 0.70
Variable selling and administrative expenses / 0.15

(i)Fixed production overheads were budgeted at $308,000 per month and were absorbed based on the number of units produced. Actual fixed production overheads of Product A were the same as the absorbed fixed production overheads for the month.

(ii)Budgeted production and budgeted sales were the same at 280,000 units per month.

(iii)Actual production and actual sales of Product A for the month were 250,000 units and 220,000 units respectively.

(iv)Actual fixed selling and administrative expenses were $110,000.

(v)There were no closing direct materials and work-in-progress inventories of Product A as at 31 January 2012.

REQUIRED:

(a)Prepare the income statement for the month ended 31 January 2012 using absorption costing.

(b)As compared with the absorption costing system, advise Perry Ltd two advantages of using the marginal costing system.

(a)

Perry Ltd
Income Statement for the year ended 31 January 2012 using absorption costing
$ / $
Sales (220,000 $5.90) / 1,298,000
Less: Cost of goods sold:
Direct materials (250,000 × $1.20) / 300,000
Direct labour (250,000 × $1.40) / 350,000
Variable production overheads (250,000 × $0.70) / 175,000
Fixed production overheads absorbed (250,000 × $1.1) / 275,000
1,100,000
Less: Closing inventory [(250,000220,000) x $4.4] / 132,000 / 968,000
Gross profit / 330,000
Less: Variable selling and administrative expenses(220,000 x $0.15) / 33,000
Fixed selling and administrative expenses / 110,000 / 143,000
Net profit / 187,000
Unit fixed production overheads absorbed = $308,000 280,000= $1.1
Unit production costs under absorption costing = ($1.20 + $1.40 + $0.70 + $1.1) or ($1,100,000250,000) = $4.4
(b) / Advantages:
—inventory valuations will not be distorted by the changes in current year’s fixed costs
—enables the company to concentrate on its controllable aspects by separating its fixedand
variable costs
—helps management to make production and sales decisions with the calculated marginalcosts
information

HKDSE Sample 1(Paper 2A, 9)(Absorption and marginal Costing)

Mary is a fresh university graduate who has majored in marketing. She is enthusiastic about conducting a business of her own alongside her full-time employment. She borrowed a sum of $90,000 from a bank at an interest rate of 5% per annum on 1 January 20X7 to run a shop which sells free-sized T-shirts of her own design.

Information relating to the shop is as follows:

(i)The shop’s rental is $5,000 per month. The annual rates and insurance expenses are $3,600 and $4,500 respectively.

(ii)A shop attendant is hired at a basic salary of $7,000 per month plus a commission of 5% of the sales value.

(iii)All T-shirts are imported from factories based on the Mainland and are sold at 100% mark-up on cost.

(iv)The budgeted sales volume is 500 shirts per month. Mary has made arrangements with the Mainland suppliers for the supply of 500 shirts each month. Then a logo sticker will be fixed on each shirt by a sewing service provider nearby at the cost of $2 each. The purchase costs for the first quarter of 20X7 are as follows:

$
January 20X7 / 22,500
February 20X7 / 24,000
March 20X7 / 25,000

(v)In order to publicise her new brand, Mary will print some promotional leaflets to be distributed once a week in the neighborhood. The printing cost of the leaflets amounts to $500 per month and a part-time worker is hired at $1,000 per month for the distribution work.

(vi)A point-of-sale system costing $30,000 was purchased to help keep inventory record and cash transactions. In addition, Mary furnished the shop with necessary furniture and fixtures by spending a further $60,000. Depreciation is to be calculated at 12% per annum on a reducing balance basis for the point-of-sale system and 10% on cost for the furniture and fixtures.

(vii)The actual sales figures for the first quarter ended 31 March 20X7 are as follows:

Number of shirts
January 20X7 / 350
February 20X7 / 420
March 20X7 / 400

REQUIRED:

(a)Define direct costs and indirect costs and identify one example for each from the case above.

(b)Compare marginal costing with absorption costing with respect to inventory valuation and income determination.

(c)Prepare an income statement for the first quarter ended 31 March 20X7 using the marginal costing method, assuming the FIFO method is adopted in the valuation of unsold goods.

(d)With the figures you have compiled in (c) above, calculate the breakeven point (in sales dollars) of the first quarter ended 31 March 20X7.

Noting that there are several giant enterprises in the low-margin garment market, Mary’s father has always persuaded Mary to discontinue her small business which is unlikely to be competitive enough to survive.

REQUIRED:

(e)Discuss two possible reasons why Mary is still enthusiastic about running a business of her own.

(a) / Direct costs –costs that would be economical to trace their cost object
e.g. purchase cost, cost of stickers, sales commission
Indirect costs –costs that would not be economical to trace their cost object
e.g. printing cost, salaries, rent and rates, insurance, depreciation

(b)

Marginal costing / Absorption costing
Inventory valuation / —Only variable costs are charged to units. / —Fixed costs are treated as product costs and can be carried forward to the next period in the value of each unit.
Income determination / —Fixed costs incurred will not be carried forward and the profit of the current accounting period will be lower. / —A proportion of the fixed costs of the current period will be carried forward to the next accounting period and therefore the profit of the current accounting period will be higher.
(c) / Income statement for the first quarter ended 31 March 20X6
$ / $
Sales [($22,500 + $24,000 + 170 x $50) x 200%] / 110,000
Opening inventories / —
Purchases ($22,500 + $24,000 + $25,000) / 71,500
Logo stickers (1,500 x $2) / 3,000
Less Closing inventories [(500 – 170) x ($50 + $2)] / (17,160) / 57,340
Product contribution margin / 52,660
Less Variable costs: Commission ($110,000 x 5%) / 5,500
Contribution / 47,160
Less: Fixed costs
Rent and rates ($5,000 x 3 + $3,600 x 3/12) / 15,900
Insurance ($4,500 x 3/12) / 1,125
Salaries ($7,000 x 3 + $1,000 x 3) / 24,000
Printing costs ($500 x 3) / 1,500
Depreciation [$30,000 x 12% x 3/12 + $60,000 x 10% x 3/12] / 2,400 / 44,925
Net profit / 2,235
(d) / Total fixed costs = $44,925
Contribution margin ratio = $47,160 $110,000
Breakeven sales dollars = Fixed costContribution margin ratio
= $44,925 / ($47,160 $110,000)
= $104,787

Longman Mock (2011, 8) (Absorption and marginal Costing)

8Genius Ltd makes a single product. The production and sales information for the year ended 31 December 2012 is as follows:

Production (units) / 350,000
Sales (units) / 395,000
Opening inventory (units) / 55,000
Selling price per unit / $130
Direct materials cost per unit / $40
Direct labour hours per unit / 3 hours
Direct labour cost per hour / $15
Variable factory overheads per unit / $11.8
Variable distribution overheads per unit / $14.5
Fixed factory overheads / $1,750,000
Fixed administrative and distribution overheads / $5,485,600

The production volume and fixed factory overheads were the same in 2011 and 2012.

Required:

(a)Calculate the unit production costs for the year ended 31 December 2012 under absorption costing and marginal costing. (3.5 marks)

(b)Calculate, under both absorption costing and margin costing, the following:

(i)Manufacturing cost of goods completed

(ii)Cost of goods sold

(iii)Closing inventory(7 marks)

(c)Prepare income statements for the year ended 31 December 2012 under both absorption costing and margin costing. (5 marks)

(d)Reconcile the difference in net profit between the two costing approaches. (1.5 marks)

(e)State the effects on the net profit calculated under absorption costing and marginal costing if:

(i)the sales volume exceeds the production volume;

(ii)the production volume exceeds the sales volume; and

(iii)the sales volume equals the production volume. (3 marks)

(Total: 20 marks)

(a)

Absorption
costing / Marginal
costing
$ / $
Direct materials / 40 / 40
Direct labour (3  $15) / 45 / 45
Variable factory overheads / 11.8 / 11.8
Fixed factory overheads ($1,750,000  350,000) / 5 / —
Unit production costs / 101.8 / 96.8
(b) / (i) / Manufacturing cost of goods completed under absorption costing = 350,000  101.8 = $35,630,000
Manufacturing cost of goods completed under marginal costing = 350,000  96.8 = $33,880,000
(ii) / Cost of goods sold under absorption costing = 395,000  101.8 = $40,211,000
Cost of goods sold under marginal costing = 395,000  96.8 = $38,236,000

(iii)

Absorption
costing / Marginal
costing
$ / $
Opening inventory (W1) / 5,599,000 / 5,324,000
Add Manufacturing cost of goods completed / 35,630,000 / 33,880,000
Cost of goods available for sale / 41,229,000 / 39,204,000
Less Cost of goods sold / (40,211,000) / (38,236,000)
Closing inventory / 1,018,000 / 968,000
W1 / Opening inventory under absorption costing = 55,000  101.8 = $5,599,000
Opening inventory under marginal costing = 55,000  96.8 = $5,324,000

(c)Under absorption costing:

Genius Ltd
Income Statement for the year ended 31 December 2012
$ / $
Sales (395,000  $130) / 51,350,000
Less / Cost of goods sold:
Opening inventory / 5,599,000
Add / Manufacturing cost of goods completed / 35,630,000
Cost of goods available for sale / 41,229,000
Less / Closing inventory / (1,018,000) / (40,211,000)
Gross profit / 11,139,000
Less / Variable distribution overheads (395,000  $14.5) / 5,727,500
Fixed administrative and distribution overheads / 5,485,600 / (11,213,100)
Net loss / (74,100)

Under marginal costing:

Genius Ltd
Income Statement for the year ended 31 December 2012
$ / $
Sales / 51,350,000
Less / Variable cost of goods sold:
Opening inventory / 5,324,000
Add / Manufacturing cost of goods completed / 33,880,000
Variable cost of goods available for sale / 39,204,000
Less / Closing inventory / (968,000) / (38,236,000)
Product contribution margin / 13,114,000
Less / Variable distribution overheads / (5,727,500)
Contribution margin / 7,386,500
Less / Fixed factory overheads / 1,750,000
Fixed administrative and distribution overheads / 5,485,600 / (7,235,600)
Net profit / 150,900
(d) / Difference in net profit = Net profit under absorption costing  Net profit under marginal costing
= $74,100  $150,900
= $225,000 (profit is lower under absorption costing)
Difference in net profit= Fixed factory overheads included in closing inventory under absorption costing
 Fixed factory overheads included in opening inventory under absorption costing
= (10,000  $5)  (55,000  $5)
=  $225,000
(e) / (i) / When the sales volume exceeds the production volume, a higher net profit figure will be
reported under marginal costing than under absorption costing.
(ii) / When the production volume exceeds the sales volume, a higher net profit figure will be
reported under absorption costing than under marginal costing.
(iii) / When the sales volume equals the production volume, the net profit figure reported will be
the same under both marginal costing and absorption costing.

HKET Mock (2011, 8) (Absorption and marginal Costing)

8.Mr. Chan just opened a shop to sell mobile phones, and at the back of the shop there is a small factory to produce the products. He purchases electronic components from suppliers and then assembles as a mobile phone for sale. In order to start the business, he borrowed $100,000 from the bank at a nominal interest rate 4% compounded monthly on 1 January 20X1. Interest expense is paid quarterly.

Information related to the shop is as follow:

(i) The rent of the shop is $8,000 per month. Electricity and water expenses are $250 per month. And there is an annual property management fee for the building of $5,000.

(ii) Mr. Chan owns this company and acts as a director. His director remuneration fee is $6,000 each month. He hires a technician to assemble the mobile phones, and the salary is $8,000 each month.

(iii)Mr. Chan bought a computer that costs $5,000 for keeping records and an equipment that costs $3,600 for the technician to assemble the electrical components and make them into mobile phones. No salvage values are expected for these assets. Asset values will be totally depreciated in 5 years with straight-line method.

(iv)Each month Mr. Chan purchased electronic components from suppliers. The costs are as follow:

Jan 20X1:$5,800

Feb 20X1:$6,700

Mar 20X1:$8,200

(v)The sales figures for the first quarter ended 31 March 20X1 are as follows:

Jan 20X1:$250,000

Feb 20X1:$230,000

Mar 20X1:$280,000

(vi)Mr. Chan classifies half of the rental payment of the shop, and 80% of the electricity and water expenses as manufacturing costs.

(vii)For the first quarter of 20X1,

the number of mobile phones produced: 350

the number of mobile phones sold:304

REQUIRED:

(a)Identify TWO direct costs and TWO indirect costs from the case above.

(b)Prepare separated income statements for the first quarter ended 31 March 20X1 using marginal costing method and absorption costing method respectively.

(c)State ONE advantage of marginal costing method over absorption costing method.

(d)Could Mr. Chan choose the method of costing by himself? Explain.

(e)Mr. Chan would like to boost the net profit by extending the useful life of assets in the next quarter’s income statement. Is this acceptable in accounting principles and in ethics?

(a) / Direct costs: Direct materials – electronic components
Direct labour – technician’s salaries
Indirect costs: 80% of the monthly electricity and water expenses for manufacturing use
50% of the monthly rental expenses for manufacturing use
Depreciation for equipment
The following items are not related to manufacturing costs:
20% of the monthly electricity and water expenses not for manufacturing use
50% of the monthly rental income not for manufacturing use
Depreciation for computer
Loan interest expenses
Director remuneration fee

(b)

Income Statement for the first quarter ended 31 March 20X1 using absorption costing
$ / $
Sales ($250,000 + $230,000 + $280,000) / 760,000
Less: Cost of goods sold:
Direct materials ($5,800 + $6,700 + $8,200) / 20,700
Direct labour (3 × $8,000) / 24,000
Manufacturing overhead cost
Electricity and water expenses ($250 x 3 x 80%) / 600
 Rental expenses for manufacturing ($8,000 × 3 x 0.5) / 12,000
Depreciation for equipment [$3,600÷5) / 4] / 180
57,480
Less: Closing inventory [(350304) x ($57,480 / 350)] / 7,555 / 49,925
Gross profit / 710,075
Less: Non-manufacturing overhead cost
Electricity and water expenses ($250 x 3 x 20%) / 150
 Rental expenses for non-manufacturing ($8,000 × 3 x 0.5) / 12,000
Depreciation for computer [$5,000÷5) / 4] / 250
 Loan interest [$100,000 x(1 + 4%/12)3 $100,000] / 1,003
Management fee ($5,000 / 4) / 1,250
Director remuneration fee ($6,000 x 3) / 18,000 / 32,653
Net profit / 677,422
Income Statement for the first quarter ended 31 March 20X1 using marginal costing
$ / $ / $
Sales ($250,000 + $230,000 + $280,000) / 760,000
Less: Variable cost of goods sold:
Direct materials ($5,800 + $6,700 + $8,200) / 20,700
Direct labour (3 × $8,000) / 24,000
44,700
Less: Closing inventory [(350304) x ($44,700 / 350)] / 5,875 / 38,825
Contribution / 721,175
Less: Fixed manufacturing cost
Electricity and water expenses ($250 x 3 x 80%) / 600
 Rental expenses for manufacturing ($8,000 × 3 x 0.5) / 12,000
Depreciation for equipment [$3,600÷5) / 4] / 180 / 12,780
Fixed non-manufacturing cost
Electricity and water expenses ($250 x 3 x 20%) / 150
 Rental expenses for non-manufacturing ($8,000 × 3 x 0.5) / 12,000
Depreciation for computer [$5,000÷5) / 4] / 250
 Loan interest [$100,000 x(1 + 4%/12)3 $100,000] / 1,003
Management fee ($5,000 / 4) / 1,250
Director remuneration fee ($6,000 x 3) / 18,000 / 32,653 / 45,433
Net profit / 675,742
(c) / Fixed costs are sunk costs. They should not be considered when managers are going to make decisions.
Any otherreasonable answers.
(d) / Mr. Chan could choose either marginal costing or absorption costing.
However, marginal costing is not acceptable if Mr. Chan is going to publish the financial statement to
thepublic.
(e) / It is not acceptable for a professional accounting treatment.
We have to keep consistency principle on preparing financial statements. Changing rules frequently will
dampen the reliability of the financial information.
Second, professional accountants should follow the Code of Ethics of being honest, straight forward
and keeping objectivity. If the reason for extending the depreciation period is to boost up net profit, it
is not an honest act.
The integrity of the professional accountant will be in doubt.

HKDSE Sample 1 (Paper 2A, 3) (Absorption and marginal costing)

Lau Yan Manufacturing Company has extracted the following information as at 31 December 20X6

$
Inventories as at 1 January 20X6: Raw materials / 40,800
Work in progress / 35,000
Finished goods / 180,000
Royalties (based on the number of units produced) / 89,000
Depreciation charge for the year: Plant and machinery / 90,200
Delivery vehicles / 897,560
Office equipment / 65,377
Direct labour / 60,800
Purchase of raw materials / 170,000
Factory manager’s salary / 57,000
Rent and electricity / 112,500
Administrative and selling expenses / 87,300
Materials loss due to fire / 50,000

Additional information:

(i)At 31 December 20X6, inventories were valued as follows:

$
Raw materials / 77,000
Work in progress / 52,000
Finished goods / 175,000

(ii)It is the company’s policy to apportion two-thirds of the costs common to both the factory and the office to the cost of production.

(iii)Finished goods are transferred to the sales department at cost plus 10%.

REQUIRED:

(a)Prepare the manufacturing account for the year ended 31 December 20X6

(b)Ascertain each of the following for the year ended 31 December 20X6

(i)Cost of raw materials consumed

(ii)Prime cost

(iii)Production cost of finished goods

(iv)Transfer price of finished goods

Answer:

(a) / Cost of raw materials consumed = $40,800 + $170,000 – ($77,000 + $50,000) = $83,800
(b) / Prime cost = $83,800 + $89,000 + $60,800 = $233,600
(c) / Production cost of finished goods
= $233,600 + ($112,500 x 2/3 + $90,200 + $57,000) + $35,000 – $52,000
= $438,800
(d) / Transfer price of finished goods = $438,800 x (1 + 10%) = $482,680

Answer:

Lau Yan Manufacturing Company
Manufacturing Account for the year ended 31 December 20X6
$ / $
Opening inventory of raw materials / 40,800
Add: Purchases / 170,000
210,800
Less: Fire Loss / 50,000
160,800
LessClosing inventory of raw materials / 77,000
Cost of raw materials consumed / 83,800
Direct labour / 60,800
Royalties / 89,000
Prime cost / 233,600
Factory overheads: Rent and electricity ($112,500 x 2/3) / 75,000
Depreciation of Plant and machinery / 90,200
Factory manager’s salary / 57,000 / 222,200
455,800
AddOpening work-in-progress / 35,000
490,800
LessClosing work-in-progress / 52,000
Production cost of finished goods / 438,800
Mark up (10%) / 43,880
Transfer price of finished goods / 482,680
(a) / Cost of raw materials consumed: $83,800
(b) / Prime cost: $233,600
(c) / Production cost of finished goods: $438,800
(d) / Transfer price of finished goods: $482,680

HKDSE Sample 1 (Paper 2A, 9) (Absorption and marginal costing)

Information relating to the shop is as follows:

(i)The shop’s rental is $5,000 per month. The annual rates and insurance expenses are $3,600 and $4,500 respectively.

(ii)A shop attendant is hired at a basic salary of $7,000 per month plus a commission of 5% of the sales value.

(iii)All T-shirts are imported from factories based on the Mainland and are sold at 100% mark-up on cost.

$
January 20X7 / 22,500
February 20X7 / 24,000
March 20X7 / 25,000

(vii)The actual sales figures for the first quarter ended 31 March 20X7 are as follows:

Number of shirts
January 20X7 / 350
February 20X7 / 420
March 20X7 / 400

REQUIRED:

(a)Define direct costs and indirect costs and identify one example for each from the case above.

(b)Compare marginal costing with absorption costing with respect to inventory valuation and income determination.

(c)Prepare an income statement for the first quarter ended 31 March 20X7 using the marginal costing method, assuming the FIFO method is adopted in the valuation of unsold goods.