Case study 1 Prism Glass Works, manufactures and sells high quality glass bottles for industrial use. The company at present reports profits on an absorption costing basis. However, Tom Cuck (the management accountant of Prism Glass Works) is not in support of continuing the use of absorption costing system due to the high fixed costs associated with the glass container industry and a substantial difference between sales volume and production in some months. Tom proposes to the top management that it would be more appropriate for the company to report profits based on marginal costing. In his proposal to management, Tom lists the following reasons in support of this proposal: (1) Marginal costing provides for the complete segregation of fixed costs, thus facilitating closer control of production costs. (2) It eliminates the distortion of interim profit statements which occur when there are seasonal fluctuations in sales volume although production is fairly constant. (3) It results in cost information which is more helpful in determining the sales policy and profit planning. From the accounting records the following figures were extracted: Budgeted cost per bottle is as follows: Particulars Amount ($) Direct materials 8.00 Direct labour 7.20 Other variable production costs 3.36 Norma Heading TH Sub Pane Note 1: Total annual fixed production overhead was budgeted at $7,584,000 and the annual budgeted production was 1,440,000 bottles. However, due to the nature of the demand, the monthly budgeted production from January to June was twice that of the Page 1 of 2 RMIT Classification: Trusted monthly budgeted production from July to December. The actual fixed overhead incurred was as budgeted. Further information: Particulars June July Bottles sold 87,000 101,000 Bottles produced 115,000 78,000 Selling price per bottle $32 $32 Fixed selling expenses $120,000 $120,000 Fixed administrative expenses $80,000 $80,000 There was no opening stock as of 1 June. Required: Focus words English (Australia) Normal Spacing Heading 1 Heading 2 Title Subtit A monthly budgeted production from July to December. The actual fixed overhead incurred was as budgeted. Further information: Particulars June July Bottles sold 87,000 101,000 Bottles produced 115,000 78,000 Selling price per bottle $32 $32 Fixed selling expenses $120,000 $120,000 Fixed administrative expenses $80,000 $80,000 There was no opening stock as of 1st June. Required: (a) Prepare income statements for the months of June and July as per absorption costing. [7 marks] (b) Prepare income statements for the months of June and July as per marginal costing. [7 marks] (c) Assess and comment briefly on Tom's three reasons which he listed to support his proposal to report profits using marginal costing. [6 marks]
