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Determine Profit in Long-Term
To demonstrate the point about profit in the long-term, let us assume that a company sells and makes a single product. There are no opening stocks of the product at the beginning of period 1, for that the variable production cost is Ksh.4 and the sales price Ksh.6 per unit. However fixed costs are Ksh.2, 000 per period, of that Ksh.1, 500 are fixed production costs,
Period
Period 2
Sales
1,200 units
1,800 units
Production
1,500 units
What would the profit be in all period utilizing the following methods of costing?
a) Absorption costing. Suppose usual output is 1,500 units per period.
b) Marginal costing.
Solution
It is significant to notice that even if sales and production volumes in each period are different and then the profit for each period via absorption costing will be different from the profit via marginal costing, over the full period, net production equals sales volume, the net cost of sales is the similar, and hence the net profit is the same via either method of accounting.
a) Absorption costing: the absorption rate for fixed production overhead is,
= £ 1,500/£1,500 units
= £ 1 per unit
Period 1
Period 3
Ksh.
7,200
10,800
Production costs
Variable
6,000
12,000
Fixed
1,500
3,000
7,500
15,000
Add opening stock b/f
-
9,000
Less closing stock c/f
Production cost of sales
6,00
(Under-)/over-absorbed overhead
Total production costs
Gross profit
1,200
1,800
Other costs
500
1,000
Net profit
700
1,300
2,000
b) Marginal Costing
Variable production cost
Variable production cost of sales
4,800
Contribution
2,400
3,600
Fixed costs
4,000
Profit
400
1,600
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