Determine Difference between Results Using Marginal Costing and Absorption Costing

The overhead absorption rate for product X is Ksh.10 per machine hour. All unit of product X needs five machine hours. Stock of product X on 1.1.X1 was 150 units and on 31.12.X1 it was 100 units.  What is the difference in profit among results reported utilizing marginal costing and results reported using absorption costing?  Is it as?

a) The absorption costing profit would be of Ksh.2, 500 less?

b) The absorption costing profit would be of Ksh.2, 500 greater?

c) The absorption costing profit would be of Ksh.5, 000 less?

d) The absorption costing profit would be of Ksh.5, 000 greater?

Solution

The main key is the change in the volume of stock. Therefore stock levels have decreased absorption costing will report a lower profit.  This removes options (b) and (d).

Option (c) is accurate since it is based on the closing stock merely 100 units x 5 hours.

The accurate answer is (a), based on the change in stock levels x fixed overhead absorption per unit

= (150 - 100) x Ksh.10 x 5

= Ksh.2, 500 lower profit, since stock levels decreased.