7.5 Reconciliation statement

RECONCILIATION OF MARGINAL PROFITS AND ABSORPTION PROFITS

 

PROFIT RECONCILIATION

There is always a difference between the profits reported using marginal costing and absorption costing. This is brought about by the difference in stock relation.

In marginal costing, stocks are valued at variable cost of production while in absorption cost they are valued at total cost.

This causes differences in the amounts that are charged to cost of sales which affects the profit reported.

 

Illustration

Langata is a manufacturing company which produces a single product. The following standard unit costs relate to the product.

Cost  Variable manufacturing Fixed manufacturing Variable selling and administration Fixed selling and administration

Sh. 90 70 16 60 236

Fixed manufacturing costs per unit are based on a predetermined absorption rate established at a normal activity level of 45,000 production unit per period. Fixed selling and administration costs are absorbed into the cost of sales at 20% of selling price.

Under/over absorbed overheads are transferred to the profit and loss account at the end of the period

The following information is available for two consecutive periods.

                                                                   Period 1                           Period 2

Sales – units                                                  42,500                          45,000

Sales – value (Sh.)                                       12,750,000                   13,500,000

Production units                                                   40,000                          46,000

Variable manufacturing costs (Sh.)                        3,600,000                     4,140,000

Variable selling and administration costs (Sh.)       3,200,000                     3,150,000

Fixed selling and administration costs (Sh.)                    680,000                         720,000

2,700,000                    2,700,000

Required

1. Income statements for each of the two periods under the absorption costing basis
2. Income statements for each of the two periods under the marginal costing basis
3. Reconciliation of the profits under the absorption costing and the marginal costing basis for each of the periods.

Solution