Comparative Analysis of Costing Methods and Financial Reporting

This report delves into the core concepts of management accounting, contrasting marginal and absorption costing techniques. It begins by defining and differentiating between marginal costing, which focuses on variable costs, and absorption costing, which incorporates both fixed and variable costs. The report provides cost cards and profit/loss statements for both methods, illustrating their practical application. Furthermore, the report includes a memo analyzing the financial health of Ffion Ltd. This section utilizes ratio analysis, including profitability, liquidity, efficiency, and gearing ratios, to assess the company's performance and financial position. The analysis provides interpretations of these ratios and offers recommendations for improving financial outcomes. The report draws upon various academic sources to support its findings and conclusions.

MANAGEMENT
ACCOUNTING AND ITS
TOOLS

TABLE OF CONTENTS
TASK 2............................................................................................................................................1
Part 1............................................................................................................................................1
Part 2............................................................................................................................................4
REFERENCES................................................................................................................................8

TASK 2
Part 1
Marginal Costing
Marginal Costing Refers to costing technique where the variable cost are charged to the
cost units & fixed costs that are attributable to relevant period are written off against contribution
for that period. It is ascertainment of the marginal costs and effects on profits of the change in
volume and output type through differentiation between fixed and variable costs. In this
technique cost are classified separately as variable and fixed cost (Eckardt, Selen and Wynder,
2015). Marginal costing concept is based over cost behaviours varying with volume of outputs .
It is also called variable costing as it includes variable costs only and per unit costs are
ascertained on the basis of variable costs (Marginal Costing, 2019).
Absorption Costing
Absorption Costing is also called full costing refers to conventional technique for
ascertaining cost. In this practice all costs both fixed and variable are charged to products,
processes and operations. This technique is widely used for ascertaining costs (LIU and PAN,
2018). This technique of costing of involves direct costs and overhead cost that are absorbed on
suitable basis. In this techniques of costing per unit cost remain constant only when output level
remains constant. When the output level changes per unit cost of products also changes due to
inclusion of fixed costs that remain constant . Absorption costing is much useful in cases when
company is manufacturing only one product and no inventory is there and recovery rate of
overhead is is based over normal capacity rather than actual activity (Lima and Moraes Filho,
2016).
Main benefit of absorption costing is it complies with GAAP & track the profits much
accurately than the variable costing (Absorption Costing, 2019). It includes all the production
cost, unlike the variable costing that considers only variable costing.
Cost card using Marginal costing
Particulars Cost per unit
Direct Material 1.375
1

Direct Labour 1.875
Marginal Cost 3.25
Selling Price 10.5
Marginal Cost 3.25
Contribution Profit Margin 7.25
'
Profit or loss statements using Marginal costing
May June
Sales Revenue
(400000*10.
5) 4200000
(360000*10.
5) 3780000
Marginal cost of sales
Direct materials
(400000*1.3
75) 550000 550000
Direct Labour
(400000*1.8
75) 750000 750000
1300000 1300000
Add: Opening Stock 0 0
Less: Closing inventory 0 1300000 130000 1170000
Contribution 2900000 2610000
Fixed production overhead 600000 600000 600000 600000
Net Income 2300000 2010000
Cost card using Absorption Costing
Particulars Cost per unit
Direct Material 1.375
Direct Labour 1.875
2

Fixed production overhead 1.5
Absorption Cost of the product 4.75
Selling Price 10.5
Total Cost 4.75
Profit 5.75
Profit or loss statements using Absorption costing
May June
Sales Revenue
(400000*10.
5) 4200000
(360000*10.
5) 3780000
Marginal cost of sales
Direct materials
(400000*1.3
75) 550000 550000
Direct Labour
(400000*1.8
75) 750000 750000
Fixed production overhead 600000 600000
1900000 1900000
Add: Opening Stock 0 0
Less: Closing inventory 0 1900000 190000 1710000
Gross Profit 2300000 2070000
Reconciliation Statement
June
Profit as per Absorption costing 2070000
+ op stk @ FOH rate at op. date 0
- Cl stk @ FOH rate at cl. date 60000
Profit as per marginal costing 2010000
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Part 2
MEMO
To - ABC, Management Ffion Ltd
From - XYZ
Date - 29th November, 2019
Subject – Financial Analysis
The present report will show the analysis of financial health and position of the company.
Ratio Analysis
Ration analysis refers to quantitative methods to gain insights into the liquidity,
profitability and operational efficiency of the company by comparing its financial information
given in the financial statements. There are different types of ratios which are used for assessing
the companies. Quantitative or fundamental analysis by analysts is referred ratio analysis. It
involves evaluation of financial health and performance of the company with the use of data
from financial statements. It enables the users of financial statements to compare the financial
position of the company with that of its competitors (Ratio Analysis, 2019).
Ratio analysis of Ffion Ltd.
Particulars Formula 2017 2018
Profitability Ratios
Return on
capital
employed
Net operating
profit/Employe
d Capital 23.21% 10.19%
Employed
Capital
Total assets –
Current
liabilities
(1700+1839)-
855 2684
(1750+2152)-
888 3014
Net operating
profit 623 307
Return on
Equity
Net Income /
Shareholder's
Equity 24.59% 10.72%
4

Net Income 623 307
Shareholder's
Equity 2534 2864
Gross profit
margin
Total Sales –
COGS/Total
Sales 23.33% 19.47%
COGS 6900 7650
Sales 9000 9500
Operating
profit margin
Operating
Income/ Net
Sales 6.92% 3.23%
Operating
income 623 307
Revenues 9000 9500
Assets
Turnover
Sales / Net
assets 335.32% 315.20%
Sales 9000 9500
Net assets 2684 3014
Liquidity Ratios
Current assets 1839 2152
Current
liabilities 855 888
Inventory 700 750
Quick assets 1139 1402
Current ratio
Current assets /
current
liabilities 2.15 2.42
Quick ratio
Current assets -
(stock +
prepaid
expenses) 1.33 1.58
Efficiency Ratios
Inventory 700 750
Trade 649 870
5

Receivables
Trade
Payables 660 690
Days 365 365
COGS 6900 7650
Sales 9000 9500
Inventory
days
Inventory/
COS*365 37.029 35.784
Debtor days
Debtor/
Sales*365 26.32 33.43
Creditor days
Creditor /
Sales*365 26.77 26.51
Gearing Ratio
Long-term debt 150 150
Shareholder's
equity 2534 2864
Debt-equity
ratio 0.06 0.05
Interpretations;
Profitability
Profitability ratios are used for assessing the performance of company in term of returns
and profits. It used to analyse how efficiently the company is able to manage its operations
(Jaafar and Thornton, 2015). High profitability shows that all the cost of the company are under
control. Ffion ltd is having return on capital employed of 23.21% for year 2017 that decreased to
10.19% in year 2018. Return on Equity of company has also declined from 24.59% to 10.72%.
Profit margin of the company has decreased to 3.23% from 6.92%. The overall profitability of
company has declined drastically as the sales has not increased in proportion to the cost expenses
of the company. Company for increasing its profitability should undertake cost control measures
and adopt for promotional strategies for increasing its sales. Profits affect the overall position of
the company in the market and represents negative image and investors starts withdrawing their
investments that decreases the share prices of company.
Liquidity Ratios
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Liquidity Ratios of the company analyse the ability of company to meet its short term
obligations with the available current assets (Lecy and Searing, 2015). Company should have
enough current assets so that short term liabilities could be met. Ffion ltd is having current ratio
of 2.15 in 2017 and 2.42 in 2018. The standard current ratio is 2:1 and company is having above
the standard ratio. Even though the profitability of company has declined its liquidity position is
strong. Excluding the inventory from the current assets company's liquidity position is slightly
lowered. Inventory is excluded as it could not generate liquidity quickly. For improving the
liquidity position it should go for long term loans instead of short term loans for meeting the
working capital requirements.
Efficiency Ratio
Efficiency ratios are used for measuring the capability of company to manage its
liabilities by effective utilisation of it assets. They enable company to identify whether they are
yielding high productivity (Chandra, 2017). Efficiency ratios of Ffion ltd were strong in the
previous year but in year 2018 they were reduced for increasing the sales and revenues for
company. The creditor days have remained constant but the debtor days were increased for
attracting more customers. The debtor days of the company should be reduced otherwise cash
cycle will get disturbed and it would not be able to pay its creditors on time (Ratio Analysis,
2019).
Gearing Ratio
It is calculated for knowing the position of debt to equity position of company. Ffion ltd
is having debt to equity ratio of 0.06 in year 2017 that was further reduced to 0.05 in 2017.
Company do not raise loans from the banks or financial institution for the business. This saves
the interest charges of the company. But long term debt could be raised by company for
improving its position and operational activities.
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REFERENCES
Books and Journals
LIU, B. and PAN, H.Q., 2018. Comparative Study of Absorption Costing and Variable
Costing. Journal of Qiqihar University (Philosophy & Social Science Edition). (6). p.22.
Lima, F.F.D. and Moraes Filho, R.A.D., 2016. Cost management strategy: absorption costing in
the small businesses in Recife, PE, Brazil. Interações (Campo Grande). 17(3). pp.528-
541.
Eckardt, G., Selen, W. and Wynder, M., 2015. Recognising the effects of costing assumptions in
educational business simulation games. e-Journal of Business Education and Scholarship
of Teaching. 9(1). pp.43-60.
Chandra, P., 2017. Investment analysis and portfolio management. McGraw-Hill Education.
Jaafar, A. and Thornton, J., 2015. Tax havens and effective tax rates: An analysis of private
versus public European firms. The International Journal of Accounting. 50(4). pp.435-
457.
Lecy, J.D. and Searing, E.A., 2015. Anatomy of the nonprofit starvation cycle: An analysis of
falling overhead ratios in the nonprofit sector. Nonprofit and Voluntary Sector
Quarterly. 44(3). pp.539-563.
Online
Marginal Costing. 2019. [Online]. Available through :
<http://www.economicsdiscussion.net/cost-accounting/advantages-and-disadvantages-of-
marginal-costing/31773>.
Absorption Costing. 2019. [Online]. Available through :
<https://corporatefinanceinstitute.com/resources/knowledge/accounting/absorption-costing-
guide/>.
Ratio Analysis. 2019.[Online]. Available through :
<https://courses.lumenlearning.com/boundless-finance/chapter/overview-of-ratio-analysis/>.
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