Question

The overhead absorption for product P is N$4 per machine hour. Each unit of P requires 3 machine hours. Inventories of product P last period were:

	Units
Opening inventory	2 400
Closing inventory	2 700

Compared with marginal costing profit for the period, the absorption costing profit for product P will be which of the following?

Select one:

a. N$3 600 higher

b. N$1 200 higher

c. N$1 200 lower

d. N$3 600 lower

e. None of all

Answer 1

Marginal costing values closing inventory at a lower cost per unit than absorption costing and this means that the cost of goods sold figure is higher using the marginal method.

Under Marginal Costing, Closing Inventory cost per unit = Total Variable cost or Marginal cost / Closing Inventory

Under Absorption Costing , Closing Inventory cost per unit = Total Cost / Total Closing inventory units.

As the value of closing stock is more in Absorption costing , hance profit will be more under Absorption Costing method

Note-

- More opening stock means profit will be less as the Opening stock is included in the COGS.

-More Closing stock means more profit , because closing stock are excluded from COGS.

	Marginal Cost	Absorption Cost
Opeing Inventory	2400 units	2400 units	Opening stock will be more in absorption costing method by =2400 units*N$4*3 =N$28800	Profit will be less by N$28800 in Absorption costing method as COGS will increase by N$28800
Closing Inventory	2700 units	2700 units	Closing stock willbe more in Absorption costing method by =2700 units *N$4*3 =N$32400	Profit will be more by N$32400 in Absorption costing methd as COGS will be less by N$32400
			Net Effect	Profit under absorption costing will be more by N$3600 ($32400-$28800)

Compared with marginal costing profit for the period, the absorption costing profit for product P will be-

a. N$3 600 higher