Marginal and Absorption Costing (End-of-unit assessment)

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1 Unit 7 Marginal and Absorption Costing (End-of-unit assessment) 1. Which of the following costing systems complies with Hong Kong Financial Reporting Standards (HKFRS) for external reporting? a) direct costing b) marginal costing c) absorption costing d) product costing a) Incorrect for internal reporting b) Incorrect for internal reporting c) Correct. Required by HKAS 2 Inventories for external reporting d) Incorrect for internal reporting 2. Woody Ltd, an office equipment manufacturer, incurred the following costs for its product Aze : Direct materials $200,000 Direct labour $150,000 Direct expenses $50,000 Indirect materials $30,000 Indirect labour $70,000 What was the prime cost for the product Aze? a) $230,000 b) $500,000 c) $350,000 d) $400,000 a) Incorrect. Wrongly included only direct materials and indirect materials costs for calculation b) Incorrect. Wrongly included up all costs for calculation c) Incorrect. Failed to include direct expenses for calculation d) Correct. Prime cost = Direct materials + Direct labour + Direct expenses 1

2 Use the following to answer questions 3 to 4. Johnson Ltd has the following costs information for the year just ended: Prime cost $300,000 Variable overhead $200,000 Fixed overhead $100,000 Period cost $200,000 During the year, 70% of the goods manufactured are sold and there is no opening stock. 3. If Johnson Ltd uses absorption costing, what is the cost of goods sold for the year? a) $350,000 b) $420,000 c) $560,000 d) $210,000 a) Incorrect. Wrongly excluded fixed overheads for calculation b) Correct. See calculation below. c) Incorrect. Wrongly used total costs for calculation. d) Incorrect. Wrongly used prime costs for calculation. Working: Calculating cost of goods sold Prime costs $300,000 Variable overhead 200,000 Fixed overhead 100,000 Product cost 600,000 Less: Closing stock (30%) 180,000 Cost of good sold 420, Assume that the sales for the year are $800,000 and Johnson Ltd uses marginal costing, what is the amount of contribution? a) $240,000 b) $590,000 c) $380,000 2

3 d) $450,000 a) Incorrect. Wrongly used total cost for calculation b) Incorrect. Wrongly used prime cost for calculation c) Incorrect. Wrongly included fixed overhead for calculation d) Correct. See calculation below Working: Calculating contribution Sales $800,000 Prime cost $300,000 Variable overhead _200,000 Variable product cost 500,000 Less: Closing stock (30%) _150,000 Variable cost of goods sold 350,000 Contribution 450, Assume that there is opening stock, which of the following is always true if units produced exceed units sold? a) Absorption costing yields a higher profit than marginal costing. b) Absorption costing yields a lower profit than marginal costing. c) Both absorption costing and marginal costing yield the same profit. d) None of the above. a) Incorrect. If the cost per unit of opening stock is higher than the production cost per unit in the current year, the profit will be lower. b) Incorrect. If the cost per unit of opening stock is less than production cost per unit in the current year, the profit will be higher. c) Incorrect. It would show different profits due to different production costs per unit absorbed in the stock produced in the current year. d) Correct. It depends on the cost of the opening stock; if the cost per unit of opening stock is less than production cost per unit in the current year, the profit will be higher. Otherwise it will be the reverse 3

4 6. Which of the following cost / expense item causes the main difference in valuing production cost between absorption costing and marginal costing? a) Variable manufacturing overhead b) Fixed manufacturing overhead c) Variable selling expenses d) Fixed administrative expenses a) Incorrect. Wrong concept applied. b) Correct. Fixed manufacturing overheads are absorbed in stock valuation in absorption costing but excluded in marginal costing c) Incorrect. Wrong concept applied. d) Incorrect. Wrong concept applied. Use the following to answer questions 7 to 8. Zen Ltd has the following cost structure for its product Z : Per unit Direct materials $100 Direct labour $200 Variable factory overhead $50 Variable selling commission $20 Fixed factory overhead, administrative expenses, selling expenses and finance expenses were $10,000, $20,000, $20,000 and $10,000 respectively, based on budgeted output of 1,000 units. 7. The selling price of product Z is determined as 200% on its total costs. What is the unit selling price of product Z? a) $600 b) $860 c) $700 d) $740 a) Incorrect. Wrongly used prime costs for pricing. b) Correct. See calculation below. 4

5 c) Incorrect. Wrongly used production costs for pricing. d) Incorrect. Wrongly used total variable costs ($370) for pricing Working: Calculate selling price Per unit Direct materials $100 Direct labour 200 Prime costs 300 Variable factory overhead 50 Fixed factory overhead ($10,000/1,000) 10 Production costs 360 Selling commission $20 Selling expenses 20 Administrative expenses 20 Finance expenses 10 _ 70 Total costs 430 Pricing percentage on total costs is 200%. Selling price ($430 x 200%) What is the unit selling price of product Z if it is priced by 230% on its marginal costs? a) $690 b) $989 c) $805 d) $851 a) Incorrect. Wrongly used prime costs for pricing. b) Incorrect. Wrongly used total costs for pricing. c) Incorrect. Wrongly used variable production costs for pricing. d) Correct. See calculation below. Working: Calculate selling price Per unit Direct materials $100 Direct labour 200 5

6 Prime costs 300 Variable factory overhead 50 Variable production costs 350 Variable selling commission 20 Marginal costs 370 Pricing percentage on marginal costs is 230%. Selling price ($370 x 230%) One reason why a company prefers the use of marginal cost for product pricing is: a) Marginal costing is more appropriate for long-term pricing strategy. b) The contribution from marginal costing is a more accurate indicator of profitability than the net profit from absorption costing. c) Marginal costing is the preferred system by accounting regulatory bodies. d) Where a range of products is manufactured, it is difficult to allocate an accurate portion of fixed costs into the products. a) Incorrect. The reverse is true. b) Incorrect. The reverse is true. c) Incorrect. Absorption costing is preferred. d) Correct. Marginal costing is more efficient under this situation than absorption costing. 10. When sales volume, unit selling price and variable cost per unit are constant, which of the following is true? a) Absorption costing shows a fluctuating per-unit net profit if production is constant. b) Marginal costing shows a fluctuating per-unit net profit if production is constant. c) Absorption costing shows a constant per-unit net profit if production fluctuates. d) Marginal costing shows a constant per-unit net profit if production fluctuates. 6

7 a) Incorrect. A constant per-unit net profit should be shown. b) Incorrect. A constant per-unit net profit should be shown. c) Incorrect. A fluctuating per-unit net profit should be shown. d) Correct. If sales volume, unit selling price and variable cost per unit are constant, the per-unit net profit should be constant under marginal costing 7

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