Example of profit manipulation under Absorption Costing

Example of profit manipulation under Absorption Costing

Following example would explain that how the profit under the absorption costing is subject to more manipulation than marginal costing.

Example

Sales Price	50 per unit
Material Direct	20  -unit
Labor Direct	10 - per unit
Expenses	5   per unit
Rent of Factory	20,000
Lightning Factory	20,000
Unit produced 2001	15,000 units
Unit Produced 2002	20,000 units

Unit Sold 2001	12,000
Unit Sold 2002	12,000

Calculated profit under Marginal Costing and absorption costing and analyze

Solution

1. Marginal Costing

	Units	Rate	2001	2002
Sales	12,000	50	600,000	600,000
Less: Variable Cost	12,000	(20+10+5)=35	(420,000)	(420,000)
Contribution			180,000	180,000
Less: Fixed Cost		(20,000+20,000)	(40,000)	(40,000)
Profit			140,000	140,000

2. Absorption Costing

Profit under 2001

	Units	Rate	Total	Total
Sales	12,000	50		600,000
Production Cost	15,000	(20+10+5)=35	525,000
Fixed Cost			40,000
Less Closing Stock	3,000	37.667	(113,000)
Cost of Sales				(452,000)
Profit				148,000

Profit under 2002

	Units	Rate	Total	Total
Sales	12,000	50		600,000
Opening Stock			113,000
Production Cost	20,000	(20+10+5)=35	700,000
Fixed Cost			40,000
Less Closing Stock	11,000	37	(407000)
Cost of Sales				(446,000)
Profit				154,000

Summary of Calculation

Year	2001	2002
Unit Sold	12,000	12,000
Marginal Costing	140,000	140,000
Absorption costing	148,000	154,000

Conclusion

The above mentioned summary clearly shows that profit under absorption costing is different for the same number of units sold during 2001 and 2002. It means that profit is subject to more manipulation under absorption costing method trough stock valuation and changing the value of Fixed overhead as compared to marginal costing method.

Marginal costing method is reporting a consistent profit of 140,000 for both years against same number of unit sold.