Example of profit reconciliation of Marginal and Absorption Costing

Example of profit reconciliation of Marginal and Absorption Costing

In below example the basic concept of the marginal costing is being clarified and therefore there is no element of inventory is included in the following 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	15,000 units
Unit Sold	10,000 units

Calculated profit under Marginal Costing and Absorption costing and reconcile the profit

Solution

If the stock level increases it means that absorption profit would be more than marginal cost to the extent amount stored in closing stock in respect of fixed overheads. Similarly if the stock level decrease then profit under marginal costing would be greater than absorption costing.

1. Marginal Costing

	Units	Rate	Total
Sales	10,000	50	500,000
Less: Variable Cost	10,000	(20+10+5)=35	(350,000)
Contribution			150,000
Less: Fixed Cost		(20,000+20,000)	(40,000)
Profit			110,000

2. Absorption Costing

	Units	Rate	Total	Total
Sales	10,000	50		500,000
Production Cost	15,000	(20+10+5)=35	525,000
Fixed Cost			40,000
Less Closing Stock	5,000	37.667	(188,333)
Cost of Sales				(376,667)
Profit				123,333

3. Profit Reconciliation

Marginal Costing Profit	110,000
Absorption Costing Profit	123,333
Difference	13,333

We see that closing stock level is increased during the year as there was no opening stock therefore the profit amount under absorption costing is more than marginal cost. This amount is exactly the same amount which was charged to closing inventory in absorption costing in respect of fixed overheads.

4. Stock valuation for fixed overheads

Fixed overhead	40,000
Number of unit produced	15,000
Unit Fixed overhead cost	=40,000/15,000 = 2.666
Stock over valued	5000 unit X 2.666 = 13,333