According to Agrawal, 2010,
Total cost = fixed cost + variable cost
Total cost = $2,500,000
Fixed cost = $800,000
Hence, Variable cost = $(2,500,000 – 800,000) = $1,700,000
But a total of 250,000 units were produced, hence variable cost per unit = $ (1,700,000/25,000) = $68
Contribution margin = (100 – 68) / 100 X 100% = 32%
Converted Variable Costing Approach
Division Income Statement
For 1st Quarter ending 31/9/2013
Production units = 25,000 units
Sales 2,500,000
Variable cost (25,000*68) 1,700,000
Contribution margin 800,000
Fixed cost (800,000)
Net profit 0
Absorption Costing Approach
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Division Income Statement
For 2nd Quarter ending 31/12/2013
Production units = 50,000 units
Sales 2,500,000
Cost of sales:
Opening stock 0
Add: Cost of goods produced (50,000*100) 5,000,000
Goods available for sales 5,000,000
Less closing stock (25,000*100) (2,500,000) 2,500,000
Gross profit 0
General expenses (350,000)
Net loss (350,000)
Variable Costing Approach
Division Income Statement
For 2nd Quarter ending 31/12/2013
Production units = 50,000 units
Sales 2,500,000
Less variable expenses:
Opening stock 0
Add variable production cost (50,000*68) 3,400,000
Goods available for sale 3,400,000
Less variable cost of goods sold (25,000*68) (1,700,000) 1,700,000
Contribution margin 800,000
Less fixed cost (800,000)
Net operating income 0
Production cost per unit for the 1st and 2nd Quarters:
- Absorption costing approach:
- Total cost/ number of units produced
But total cost = cost of sales + expenses
= (1,800,000 + 350,000)/25,000
= $86
- Total cost/ number of units produced
But total cost = cost of sales + expenses
= (2,500,000 + 350,000) / 25,000
= $57
- Marginal costing method
- Cost of production per unit = Total cost/total quantity produced.
Where, Total cost = Fixed cost + variable cost
= (1,7000,000 + 800,000)/25,000
= $100
- Cost of production per unit = Total cost/total quantity produced.
Where, Total cost = Fixed cost + variable cost
= (3,4000,000 + 800,000)/50,000
= $84
I would advise the division to employ the marginal cost absorption method of cost accounting in the future instead of the absorption method.
According to me, Mr. Rosen should be considered for the position of the CEO since he looks determined to increase the output of the firm while reducing or rather cutting down production costs.
Limitations of absorption method for internal decision making
Fixed costing such as depreciation, rent and salaries relate to a period of time and should be charged against the revenues of the period in which they were incurred (Berry, 2006).
Secondly, it’s not easy to compute. Only individuals with the correct accounting knowledge are capable of computing it (Learn accounting online, 2013).
Different products have different cost behaviors. This implies that it may not give the real cost of manufacturing a particular product (Accounting world, 2013).
References
ACCOUNTING-WORLD: Accounting Explanation. (n.d.). ACCOUNTING-WORLD: Accounting Explanation. Retrieved December 23, 2013, from http://www.accounting-world.com/p/accounting-explanations.html
Agrawal, N. K. (2010). Principles of Management Accounting. New Delhi: Asian Books.
Berry, L. E. (2006). Management Accounting Demystified. New York: McGraw-Hill.
Learn Accounting Online for Free. (n.d.). Learn Accounting Online for Free. Retrieved December 23, 2013, from http://accountingexplanation.com/
