Assessment: Individual coursework – Laura Silenzi K1737970
Task 1
1) Different Profit with Absorption and Marginal costing
Profit and loss can be different with the same information based on the different method of costing used.
Under the Absorption costing method the fixed manufacturing overhead costs are involved to calculate the cost of good sold.
In this case if at the ends of the year there’s an increase in closing stock, there is a Fixed Manufacturing overhead deferred in time, this means that the part of costs referred to this year are deferred in stock for the next year, and they will not form the profits or loss; and the value of the closing stock is higher than the second method.
Under the Marginal costing method the entire amount of fixed manufacturing overhead costs are treated from the current year; and the closing stock value is lower than the first method.
This different treatment for fixed manufacturing overhead costs cause a different results about profits or loss; When the amount of this cost is high, the decision making process can be affected by the result of the balance shit.
The evaluation of the different methods is not easy:
• Absorption costing considers the fixed manufacturing overhead costs part of the cost of products, and for this reason costs should be charged for each units of good sold.
• For Marginal costing the fixed manufacturing overhead costs should be expensed totally in the current period.
The choice depends on the company evaluations.
The problem can be the evaluations of the profits or loss in the year; if the management change and the method change, it should seems that the company suddenly is performing well; in the other case, if the method change from Marginal to Absorption it should seems that the profits are decreasing or the loss increasing. This difference can lead to misinterpretations and even wrong decision because
2) Cost–volume–profit Analyses
With the Absorption costing, the costs included in the amount are fixed and variable, while in the Marginal costing all the costs considered are variable.
Cost-volume-profit analyses needed for planning and control process should need the use of consistent amount of time causing problems to reclassify costs to make the analyses possible.
In this case is preferred the second costing approach in order to the contribution analyses to the profits or loss, the advantage is that the direct costing data could be immediately used in CVP calculations. Calculation of a “margin” is preferable in order to know the contributive capacity of each product to the defrayment of fixed manufacturing overhead. The readily available data on direct cost and contribution margin permits quick answers to the scores of cost decisions that management must make each day (Bunea-Bontaş – 2013).
3) Changes in production
A change in production under variable costing Is not impacting the profits when we use the variable costing, while with the use of Absorption costing profits or loss are affected
4) Fixed manufacturing overhead seems variable.
With the absorption costing the amount of fixed manufacturing overhead per units is calculated by total Fixed Manufacturing Overhead / Units; and seems to be variable with the number of units sold, but they are not.
In the SleepEase’s If the company produced one item the cost of absorption unit cost is 766,67 £ but the variable portion is 600 £ and the fixed portion is 166,67£; Since the product costs are calculated in terms of per unit item, managers can made a mistake believed the production of one more item costs at the company 766,67£ rather than 600£.
This misperception of the costs per unit can cause lot of problems to the managers:
– problem with the price of the good
– problem with the drop of production that seems to be in loss, but actually is profitable
– problem with the price of orders in order to discount for clients
The advantage in using variable costing is that the cost of products does not contain fixed manufacturing overhead costs.
According to Bunea-Bontaş (2013) in terms of decision making on the future business, direct costing provides a solid basis for cost planning and for studying the effects of planned changes on the volume of production, determined by changes in economic conditions or specific managerial decisions, such as: selling price variation, increasing or decreasing inventories, promotional sales.
Cost card Absorption costing 2015
Cost card Marginal costing 2015
Direct materials
£300,00
Direct materials
£300,00
Direct Labour
£200,00
Direct Labour
£200,00
Variable Man Oh
£100,00
Variable Man Oh
£100,00
Fixed Man. Oh
£166,67
Marginal cost
£600,00
Full cost
£766,67
5) Easily comprehensible form
The variable costing is easy to understand from clients and managers and easier to estimate; while the absorption costing is challenging and not clear.
The advantage for the company in using the marginal costing is that can use less amount of time, and be sure that every shareholder can easily understand the costs of good sold and the costs involved.
The problem of absorption costing is that the profits are decreased by the fixed amount of costs
6) Financial position and financial performance
According to Bunea-Bontaş (2013) computing the cost of production under direct costing or under absorption costing will affect the financial position through the cost of ending inventory and the financial performance through the cost of goods sold.
The statements of financial position prepared both under direct costing and under absorption costing
produce different figures for the amount of inventories.
At the same condition the amount of net assets under absorption costing is higher than under direct costing.
Task 2
The Absorption costing show:
• In 2015 the company has yielded Net profit for 143,000£ but in 2016 only 108,000£ decreasing the 25% of the profits of the first year.
• The Cost of sales decrease from 920,000£ to 680,000£, in a preliminary analyses this can be considered a positive change, but if we look at the meaning of the amount in 2016, it’s easily understandable that the decreasing of the cost of sales depend on the decrease of the Max-ease beds production from 1200 to 800 items.
• In the first year the company has Closing stock for 230,000£, 1/4 of the entire productions in term of units, and the 25,5% of the sales.
This amount affected the 2016, because it cause the decrease of gross profit.
As explained in the first task, this is caused from the deferring of the Fixed manufacturing overhead costs.
This costs, indeed, are cost of the 2015 period, that are attached with the single closing item.
Deferring this costs to the following year the gross profit of the firs year increase, but decrease in 2016.
The Marginal costing show:
• In 2015 the company has generated Net profit for 93,000£ but in 2016, 133,000£ increasing the 43% of the profits of the first year.
• The Cost of sales decrease from 720,000£ to 480,000£, but for the same reason of the Absorption costing method this is caused from the decrease of the production.
• In the first year the company has Closing stock for 180,000£, 1/4 of the entire productions in term of units, but only the 20% in term of sales.
With this method the fixed manufacturing overhead costs are charged in the first year, and this leave the gross profits and then the net profits increase for 2016.
Difference between Absorption and Marginal costing:
• The main difference is the progress of profits: with the full costing in 2016 the company loss the 25% of the profits, while with the variable costing the company increase the 43% of net profits.
Reconciliation prospect
As the reconciliation prospect shows the difference between Absorption and Marginal cost are the fixed manufacturing overhead costs.
Task 3
The deal with Mr. Spenser was a bonus of £10,000 if he achieved a 10% increase in sales on 2015 providing the business also increased net profit by 10%.
The board’s decision not to pay Mr. Spenser seems to be right if we look at the first Absorption costing method, in 2015 the sales was 900,000£ and in 2016 was 1,000,000£ gained a + 11,15%.
But the net profit decrease 25% from 143,000£ In 2015 to 108,000£ in 2016.
The increasing of 11,15% was not sufficient to increase net profit, this is why the company can’t pay the bonus to Mr Spenser.
At the opposite side if we use the Variable costing the same value for the sales: in 2015 was 900,000£ and in 2016 was 1,000,000£ gained a + 11,15%; and the net profit increase from 93,000£ to 133,000£ gaining the 43% of the profits of the first year.
In this case the company should consider the goal achieved and Mr. Spenser should receive the bonus.
The decision appears right in both situation but as explained in task 1, one of the main problem with the Absorption costing is the Fixed manufacturing overhead deferred timing.
This costs are part of the 2015 and they should be charged in the first year as the Variable costing method do. The fact that the costs are deferring in time change the profitability of the company, and might obscure the real increase in net profit raised by Mr. Spenser.
The amount of the difference between the first and the second method is definitely relevant in term of company management and decision making.
Looking at the full costing method the company should decide to dismiss the production of Max-ease beds, or change the bed to increase the sales; but it should be a wrong decision. Instead if we consider the variable costing the company seems to be profitable and the Max-ease beds a good product.
Task 4
“The balanced scorecard is like the diais in an airplan cockpit: it gives managers complex information at a glance.” (Robert S. Kaplan and David P. Norton – Measures That Drive Performance).
With the evolution of the market the balanced presentation of financial and operational measures is becoming more important and the company should provide at the manager both type of analyses.
The balanced scorecard limite the number of measures used to reduce the informations obliging managers to focus on the most critical measurements; it many of the apparently main elements of a company's competitive agenda: customer oriented strategy, increase quality, stressing teamwork, reducing launch times, and managing for the long term.
the balanced scorecard lets the managers see whether improvement in one area may have been caused at the expense of another.
The balanced scorecard focus on four important perspectives:
1-Customer Perspective: how the clients consider the company
The priority for top management is nowadays how costumers considered the performance of the company.
To ensure the functioning of balanced scorecard, companies should convert general mission into specific goals for time, quality, performance and service and translate its into specific measures.
2-Internal Business Perspective: the core competences in the company
The second part of the balanced scorecard gives the internal perspective of the company.
The internal measures of the business processes that have the best impact on customer satisfaction as for example, cycle time, quality, post sales service.
company's core skills and critical technologies required to guarantee the market leadership are the main measures for the companies that should decide what processes and competencies they must excel at and specify measures for each.
3-Innovation and Learning Perspective: Improvement and Creation of Value
Intense market competition requires that companies.
The main point of the section is the measurement of the ability to continualy improve existing products and processes and, at the same time, have the capability to launch new products to create more value for clients, and increase revenues and margins to grow and increase shareholder value.
4-Financial Perspective: How the stakeholders consider the company
Financial performance analyse the company's strategy, implementation, and execution and typical financial goals have to deal with profitability, growth, and shareholder value.
Sometimes the measure can create misperception because of their backward-looking focus, and their inability to reflect contemporary value-creating actions.
“Scorecard represents a fundamental change in the underlying assumptions about performance measurement, and puts strategy and vision, not control, at the center “ (Robert S. Kaplan and David P. Norton – Measures That Drive Performance).
The measures are designed help the management to increase the value of the company, and to help the entire company to understand the main goals to reach and the requirement that the goals have, forgetting the financial aspect of the company.
References
-The balanced scorecard – measures that drive performance. (includes related articles)
Kaplan, Robert S. ; Norton, David P.
Harvard Business Review, Jan-Feb, 1992, Vol.70(1), p.71(9)
-Seal, W., Garrison, R. and Noreen, R. (2012) Management Accounting,
(4th edition), McGraw Hill. Chapter 6 p. 200 – 227
THE COST OF PRODUCTION UNDER DIRECT COSTING AND ABSORPTION
COSTING – A COMPARATIVE APPROACH
Bunea-Bontaş Cristina Aurora
Lecturer Ph.D.
“Constantin Brâncoveanu” University of Piteşti
The Faculty of Management Marketing in Economic Affairs Brăila
bontasc@yahoo.com
2/2013