Management Accounting 1B

AAM3692

Unit 1

Variable and Absorption Costing

04 AUGUST 2026
 1.1Learning Objectives
• Define Marginal/Variable Costing & Absorption
Costing
• Identify - what distinguishes variable costing from
absorption costing.
• Compute - Comprehensive Income under Absorption
costing and Variable costing and reconcile the profit.
Understand - how absorption and variable costing
methods differs and what causes the differences in
profit thereof.
1.2 Overview of Variable Costing
• Is a technique of presenting cost data
• Variable costs and Fixed costs are shown separately
for managerial decision making
• Marginal / Variable cost is not a cost method
(processing and Job costing), but it is simply a
method of the analysis of cost information in
analysing effect on profit due to changes in the
volume of output or costs
• Recognized for reporting and decision making
internally
• All fixed cost treated as period cost
• If there are two periods, opening stock valued at
variable cost per unit.
• Non-Manufacturing cost must be added to marginal
cost of production to get total Variable cost of sale.
Do not include non-manufacturing cost in stock
valuation
MARGINAL COSTING FORMAT TO FOLLOW
1.3 Possible Format - Variable Costing N$
Sales (Unit Sold*Selling Price) xxxx
- Variable Cost Of Sales
Opening Stock - valued at previous VMC/per unit xxxx
+ Production Cost (DM, DL, Overhead (Variable) xxx
(Value @ Marginal cost)
= Cost of Goods Available for Sale xxx
Less Closing Stock-Value at marginal costing per unit (xxx)

Marginal cost of production xxx

+ Non- Manufacturing - Variable Selling & Admin Costs xxx
Variable Cost of Sales (xxx)
= Contribution xxx
- Period Cost / Fixed Cost
Production / Manufacturing costs - Fixed (xxx)
Selling & Administration Costs – Fixed (xxx)
= Profit/ (Loss) for the period xxx
Example for Marginal and Absorption Costing

Illustrative example 1
Four Seasons (Pty) Ltd manufactures a single product. The details of
processing for March 2021 were as follows: There were 100 000 units
manufactured and sold at R16 per unit. Fixed manufacturing costs were
R350 000, and the variable manufacturing cost was R5 per unit. Selling
and administration costs were R50 000 for fixed and R120 000 for
variable. The allocation base is units of output, and the annual budgeted
output is 140 000 units.
Required:
Draft the statements of comprehensive income of Four Seasons (Pty)
Ltd for March 2021 by means of the direct costing and absorption
costing methods.
 Four Seasons (Pty) Ltd:
Statement of comprehensive income for month ended 31 March 20.1
Direct costing method

R R
Sales 1,600,000.00
Less: Variable cost of sales
Opening inventory – -
Variable manufacturing cost (100 000 × 51)
500 000 500,000.00
Less: Closing inventory – -
Marginal cost of production 500,000.00
Add Variable selling and administrative costs
(non-manufacturing) 120,000.00
Variable cost of sales 620,000.00

Contribution 980,000.00
Less: Fixed costs

Manufacturing 350,000.00
Selling and administrative costs 50,000.00 400,000.00
Net profit 580,000.00
1.4 Overview- Absorption / Product
Costing

• Widely accepted for external reporting

• Assign fixed production costs to products

• Only non- production costs are treated as period cost (both

fixed and variable cost).
• Adjustment for Over or Under Absorption/recovery (overheads
charged to production are higher than actual overhead: We over
absorbed /recovered -increase your gross profit with this
amount. Overheads charged to production are lower than the
actual overhead-we under absorbed /recovered - decrease your
gross profit with this amount.

• If there are two periods, opening stock, valued at opening

absorption cost per unit.
ABSORPTION COSTING FORMAT TO FOLLOW
1.5 Possible Format - Absorption Costing N$
Sales (Unit Sold*Selling Price) xxx
- Cost Of Sales
Opening Stock - valued at previous Abs. C/per unit xxx
+ Cost of Goods Manufactured/Production cost @ xxx
absorption cost (D. M+D.L+[Link]+[Link]
Allocated)
= Cost of Goods Available for Sale xxx
Less Closing Stock (Valued @ absorption cost per (xxx)
unit)
Cost of sales (xxx)
+/- Under/(Over) Allocated Overhead xxx
= Gross Profit xxx
- Period Cost -Non-Manufacturing costs
Selling costs – Variable / Fixed xxx
Administration costs – Variable/ Fixed xxx
= Profit/ (Loss) for the period xxx
 Illustrative example 2 (Same information as in
example 1)

Four Seasons Pty Ltd

R R

Sales 1,600,000.00
Less: cost of sales

Opening inventory – -

Manufacturing overheads (5+2.5=7.50) 750,000.00

Less: Closing inventory – -

Cost of sales 750,000.00

Under recovery /absorption (250 000-350
0000) (100 000)

Gross Profit 750,000.00

Less: Non-Manufacturing costs

Variable Selling and Admin 120,000.00

Fixed Selling and administrative costs 50,000.00 170,000.00

Net profit 580,000.00

Budgeted fixed overheard rate (Pre -determined overhead rate) =
N$350 0000/140 000 units =N$2.50
1.6 Reconciliation of profit
Profit as per Marginal Costing Method XXXXXX
- Opening Stock Units x Fixed Cost Per (XXXXX)
Unit
+ Closing Stock Units x Fixed Cost Per XXXXX
Unit
Profit as per Absorption Costing XXXXXX
Method
NB
(differences in stock movement X OAR)
 Alternatively !

XXXXXX
Profit as per Absorption Costing
Method
+ Opening Stock Units x Fixed Cost Per XXXXX
Unit
- Closing Stock Units x Fixed Cost Per (XXXX)
Unit
Profit as per Marginal Costing Method XXXXXX
 1.7 Causes of differences in the profit between the two
systems

• Variable costing / Marginal costing / Direct costing

Treats all Fixed costs as period costs. (Fixed
production, Fixed Selling and Administration.)

• Absorption Costing / Product Costing

Absorb fixed manufacturing costs into the
product/inventory. (Included in the cost goods
manufactured and in inventory).
General Rule
• When production equals sales, profits will be the same
under the direct costing method and the absorption
cost method.
• When production exceeds sales and there is an
inventory buildup, absorption costing reports the
higher profit.
• When sales exceed production and the inventory is
reduced, direct costing will show a higher profit.
1.8 Manufacturing Cost Per Unit
Calculations

Item Variable Absorption

Costing Costing
Direct Material [Link] [Link]
Direct Labour [Link] [Link]
Other Variable M.O.C [Link] [Link]
Fixed M. O. C [Link]
Total M. Cost per unit [Link] [Link]
1.9 Inventory Calculations

Item Year 1 Year 2

Opening stock XXXX XXXX
+ Production XXXX XXXX
= Available for Sales XXXXX XXXXX
- Sales (XXXX) (XXXX)
= Closing stock XXXX XXXX
1.10 Practical!

Tutorial Questions and Past Exam

questions papers

Please Read Further !