Advanced: Explanation of absorption costing changes in profits and preparation of variable costing profit statements The Miozip Company operates an absorption costing system which incorporates a factory-wide overhead absorption rate per direct labour hour. For 1980 and 1981 this rate was £2.10 per hour. The fixed factory overhead for 1981 was £600000 and this would have been fully absorbed if the company had operated at full capacity, which is estimated at 400000 direct labour hours. Unfortunately, only 200 000 hours were worked 1n that year so that the overhead was seriously underabsorbed. Fixed factory overheads are expected to be unchanged 1n 1982 and 1983.

The outcome for 1981 was a loss of £70 000 and the management believed that a major cause of this loss was the low overhead absorption rate which had led the company to quote selling prices which were uneconomic.

For 1982 the overhead absorption rate was Increased to £3.60 per direct labour hour and selling prices were raised in line with the established pricing procedures which involve adding a profit mark-up of SO% onto the full factory cost of the company's products. The new selling prices were also charged on the stock of finished goods held at the beginning of 1982.

In December 19821he company's accountant prepares an estimated Profit and Loss Account for 1982 and a budgeted Profit and Loss Account for 1983. Although sales were considered to be depressed in 1981 , they were even lower in 1982 but, nevertheless, it seems that the company will make a profit for that year. A worrying feature of the estimated accounts is the high level of finished goods stock held and the 1983 budget provides for a reduction in the stock level at 31 December 1983 to the (physical) level which obtained at the 1 January 1981 . Budgeted sales for 1983 are set at the 1982 sales level.

The summansed profit statements for the three years to 31 December 1983 are as follows:

(a) You are required to write a short report to the board of Miozip explaining why the budgeted outcome for 1983 is so different from that of 1982 when the sales revenue is the same for both years. (6 marks)

(b) Restate the Profit and Loss Account for 1981, the estimated Profit and Loss Account for 1982 and the Budgeted Profit and Loss Account for 1983 using marginal factory cost for stock valuation purposes. (8 marks)

(c) Comment on the problems which may follow from a decision to increase the overhead absorption rate in conditions when cost plus pricing is used and overhead is currently underabsorbed.
(3 marks)

(d) Explain why the majority of businesses use lull costing systems whilst most management accounting theorists favour marginal costing. (5 marks)
NB Assume in your answers to this question that the value of the £
and the efficiency of the company have been constant over the period under review.

Transcribed Image Text:

Summarized Profit and Loss Accounts Actual 1981 Estimated 1982 Budgeted 1983 (E) () () (E) (E) Sales Revenue Opening Stock of 1350000 1316250 1316250 Finished Goods 100000 200000 357500 Factory Cost of Production 1000 000 975000 650000 1100000 1175000 1007500 Less: Closing Stock of Finished Goods 200.000 357 500 130000 Factory Cost of Goods Sold 900 000 817500 877500 450 000 498 750 438750