Galway Plc manufactures and sells a single product .The following budgeted/ actual information is provided in relation to the production of this product:

Question

Tshs Selling price per unit 50.00
Direct materials per unit 8.00
Direct labour per unit 5.00
Variable production overheads per unit 3.00

Details for the months of May and June 2010 are as follows:
May June
Production of Product A 500 380
Sales of Product A (units) 300 500

Fixed production overheads are budgeted at €4,000 per month and are absorbed on a unit basis. The normal level of production is budgeted at 400 units per month.
Other costs
Fixed selling €4,000 per month
Fixed Administration €2,000 per month
Variable sales commission 5% of sales revenue
there was no opening inventory of Product A at the start of May.
Required: produce operating statements based upon marginal costing and absorption costing principles and reconcile profit

Answer 1

To produce the operating statements based on marginal costing and absorption costing principles and reconcile the profit, we shall first outline the necessary calculations for both costing methods.

### 1. Marginal Costing Operating Statements

#### May:
**Revenue:**
- Sales = 300 units
- Selling price = €50 per unit
- Total Sales = 300 * €50 = €15,000

**Variable Costs:**
- Direct Materials = 300 units × €8 = €2,400
- Direct Labour = 300 units × €5 = €1,500
- Variable Production Overheads = 300 units × €3 = €900
- Variable Sales Commission (5% of sales revenue) = 5% of €15,000 = €750

**Contribution:**
- Total Variable Costs = €2,400 + €1,500 + €900 + €750 = €5,550
- Contribution = Sales - Total Variable Costs = €15,000 - €5,550 = €9,450

**Fixed Costs:**
- Fixed Production Overheads = €4,000
- Fixed Selling = €4,000
- Fixed Administration = €2,000
- Total Fixed Costs = €10,000

**Profit:**
- Profit = Contribution - Total Fixed Costs = €9,450 - €10,000 = (-€550)

#### June:
**Revenue:**
- Sales = 500 units
- Selling price = €50 per unit
- Total Sales = 500 * €50 = €25,000

**Variable Costs:**
- Direct Materials = 500 units × €8 = €4,000
- Direct Labour = 500 units × €5 = €2,500
- Variable Production Overheads = 500 units × €3 = €1,500
- Variable Sales Commission (5% of sales revenue) = 5% of €25,000 = €1,250

**Contribution:**
- Total Variable Costs = €4,000 + €2,500 + €1,500 + €1,250 = €9,250
- Contribution = Sales - Total Variable Costs = €25,000 - €9,250 = €15,750

**Fixed Costs:**
- Fixed Production Overheads = €4,000
- Fixed Selling = €4,000
- Fixed Administration = €2,000
- Total Fixed Costs = €10,000

**Profit:**
- Profit = Contribution - Total Fixed Costs = €15,750 - €10,000 = €5,750

### 2. Absorption Costing Operating Statements

To calculate the cost per unit under absorption costing, we'll include fixed production overheads. The normal level of production is 400 units per month.

**Fixed Production Overhead per Unit:**
- Fixed Overhead per unit = €4,000 / 400 units = €10 per unit

#### May:
**Revenue:**
- Sales = 300 units * €50 = €15,000

**Cost of Goods Sold:**
- Variable Cost per unit = €8 + €5 + €3 = €16
- Absorbed Fixed Overhead per unit = €10
- Total Cost per unit = €16 + €10 = €26
- Cost of Goods Sold = 300 * €26 = €7,800

**Under/Over Absorption:**
- Produced Units = 500
- Fixed Overhead Absorption = 500 * €10 = €5,000
- Budgeted Fixed Overhead = €4,000
- Over-absorbed Overhead = €5,000 - €4,000 = €1,000

**Gross Profit:**
- Gross Profit = Revenue - COGS + Over-absorbed Overhead = €15,000 - €7,800 + €1,000 = €8,200

**Non-production Fixed Costs:**
- Fixed Selling = €4,000
- Fixed Administration = €2,000
- Total Fixed Costs = €6,000

**Profit:**
- Profit = Gross Profit - Fixed Costs = €8,200 - €6,000 = €2,200

#### June:
**Revenue:**
- Sales = 500 units * €50 = €25,000

**Cost of Goods Sold:**
- Variable Cost per unit = €8 + €5 + €3 = €16
- Absorbed Fixed Overhead per unit = €10
- Total Cost per unit = €16 + €10 = €26
- Cost of Goods Sold = 500 * €26 = €13,000

**Under/Over Absorption:**
- Produced Units = 380
- Fixed Overhead Absorption = 380 * €10 = €3,800
- Budgeted Fixed Overhead = €4,000
- Under-absorbed Overhead = €4,000 - €3,800 = €200

**Gross Profit:**
- Gross Profit = Revenue - COGS - Under-absorbed Overhead = €25,000 - €13,000 - €200 = €11,800

**Non-production Fixed Costs:**
- Fixed Selling = €4,000
- Fixed Administration = €2,000
- Total Fixed Costs = €6,000

**Profit:**
- Profit = Gross Profit - Fixed Costs = €11,800 - €6,000 = €5,800

### 3. Reconciliation of Profits

**May:**
- Marginal Costing Profit = -€550
- Absorption Costing Profit = €2,200
- Difference = ¥2,200 - (-€550) = €2,750
This difference is due to the over-absorbed fixed production overhead (500 units produced vs 400 units budgeted at €10 per unit), plus the €1,200 opening inventory valuation difference (200 units at €6 [(€16 Direct Variable + €10 Fixed) - 16(Direct Variable)]).

**June:**
- Marginal Costing Profit = €5,750
- Absorption Costing Profit = €5,800
- Difference = €5,800 - €5,750 = €50
This difference is due to the 20 units of closing inventory (20 * €10).

The total profits are reconciled between the two methods by adjusting for fixed overheads included in inventory values.