Management Accounting: Absorption and Marginal Costing Analysis

Desklib provides solved assignments and past papers to help students succeed.

Management Accounting
1

Table of Contents
Task 2...................................................................................................................................................3
Part -1 - Absorption and Marginal Costing........................................................................................3
Part-2 - Financial Ratio Analysis.......................................................................................................6
References:.........................................................................................................................................10
Appendix............................................................................................................................................11
2

Amount ( In Unit ) Units Amount (£) Amount ( In Unit ) Units Amount (£)
Sales 10.50 400,000 4,200,000 10.50 360,000 3,780,000
Variable Cost -
Direct material 1.38 400,000 550,000 1.53 360,000 550,000
Direct Labour 1.88 400,000 750,000 2.08 360,000 750,000
Contribution 7.25 400,000 2,900,000 6.89 360,000 2,480,000
Fixed Cost -
Fixed Production overhead 1.50 400,000 600,000 1.67 360,000 600,000
Total Cost of production / Cost of Sales 4.75 400,000 1,900,000 5.28 360,000 1,900,000
Net Profit Under Marginal Costing 5.75 400,000 2,300,000 5.22 360,000 1,880,000
June
Particular May
Task 2
Part -1 - Absorption and Marginal Costing
Eymen Ltd is a company which is engaged in the production or manufacturing practices. The
company produced a single product for which they want to assess the cost of production and
also wants to identify the profit from their business activities. Here the company can use two
kinds of tools for identified the profit from the production activities of the company.
Marginal Costing
Marginal costing is the method which helps the company to identify the profit from their
production activities. Marginal costing helps management to identify the marginal cost which
is charged on the production and also helps to identify the fixed cost for the production.
Income statement as per marginal Costing
Under marginal costing Company earn the profit
of
23,00,000
and 18,80,000 in the respective month of May and June. During the month of June, the
company sold 3,60,000 units from the overall production of 4,00,000 which means the
company had 40,000 in closing stock which is not recorded for calculation of profit under
marginal costing.
3

Amount ( In Unit ) Units Total Amount ( In Unit ) Units Total
Sales 10.50 400,000 4,200,000 10.50 360,000 3,780,000
Cost of Good sold
Direct Material 1.38 400,000 550,000 1.38 400,000 550,000
Direct Labour 1.88 400,000 750,000 1.88 400,000 750,000
Prime Cost 3.25 400,000 1,300,000 3.25 400,000 1,300,000
Production overhead
Fixed Production overhead 1.50 400,000 600,000 1.50 400,000 600,000
Cost of Production 4.75 400,000 1,900,000 4.75 400,000 1,900,000
Administration expenses - 400,000 - - 400,000 -
Selling and distiribution expenses - 400,000 - - 400,000 -
Cost of Sales 4.75 400,000 1,900,000 4.75 400,000 1,900,000
Less:- Closing Inventory 4.75 - - 4.75 40,000 190,000
Cost of Good sold 4.75 400,000 1,900,000 4.75 360,000 1,710,000
Net Profit Under Absorbtion Costing 5.75 400,000 2,300,000 5.75 360,000 2,070,000
May June
Particular
Absorption costing technique: Absorption costing is the method which helps management
in identification and presentation of income statement so that they are able to identify the
profit of the company. Absorption costing records cost elements which are absorbed by the
cost centre in their production activities.
Income statement as per Absorption Costing
Under
this method, the production of the company is approx. 4,00,00 units in both month and the
profit for the month of May is 2,300,000 and profit for the month of June is 2,070,000 from
the production activities of the company.
Reconciliation Statement
Particulars May June
Marginal Costing 2,300,000 1,880,000
Add - Over absorptions on cost center - 190,000
Absorption costing Profit 2,300,000 2,070,000
4

In the month of June Company identified there is a significant difference among the profit
under marginal costing and absorption costing. When the management work on the issue they
identified that company incurred the cost of production on 4,00,000 units but marginal
costing only identified the cost which is incurred on unit sold by the company which is
3,60,000 so that there is a major difference of closing inventory of 4,000 unit worth 1,90,000
for the company. This indicates that marginal costing is not able to consider the inventory in
their profit calculation so that management of the company can adopt the absorption costing
for accounting purpose of costing which helps them to identify the realistic value of profit
which is earned by the company from their production activities.
5

Part-2 - Financial Ratio Analysis
Financial Ratio is the tool which helps management in the identification of financial
performance of the company and also guides to take major decision to improve the financial
performance of the company. The financial ratio can be a major tool which helps
management in analyzing the financial information of the company so that they are able to
identify the major issue which can be overcome through corrective action adopted by the
company.
Here are the financial information is recorded which are used for financial ratio analysis of
the financial statement of the company.
Financial Information of Rio Tinto for 2018
Particular Amount
Sales Revenue From Operations 40,552.00
Operating Profit 17,687.00
Current Assets 20,168.00
Quick Assets 16,721.00
Current Liability 10,571.00
Equity Shareholder fund 49,823.00
Debts Fund 12,847.00
Average Debtors 3,311.00
Average Creditor 6,830.50
Average Inventory 3,459.50
Cost of Goods Sold 27,115.00
EBIT 18,200.00
Interest Expenses 552.00
Net Profit 13,925.00
Total Assets 90,949.00
Market Value of share
Fixed Assets 70,047.00
Total Liability 41,126.00
6

Financial Result of Ratio Analysis
Particular Formula Result
Profitability Ratio
Margin Profit on sales Operating Profit / Sales 0.44
Return on capital employed EBIT / Capital Employed 0.37
Liquidity Ratio
Quick ratio Quick Assets / Current Liability 1.58
Current Ratio Current Ratio / Current Liability 1.91
Efficiency Ratio
Stock Turnover Period (Average Stock ÷ Cost of Sales) *365 47
Debtor Turnover Period (Average debtors ÷ Sales) *365 45
Gearing Ratio
Gearing Ratio
(Total liability - current liability)/ Capital
Employed 0.61
Interest cover ratio EBIT / Interest Charges 32.97
Investor Ratio
Earnings Per Share Earning / Number of share 793.20
Memo for Financial Interpretations
7

To Board of Director
From XYZ Consultant
Dated on 17.06.2019
Subject – Financial performance of Rio Tinto in 2018
This Memo is created to provide the relevant information about the financial performance of
the company which is provided by financial ratio analysis on the financial information of the
company. Here some of the aspects of the company are an analysis which is listed as follows
 Profitability Ratio - During the financial analysis profitability ratio is used to identify
the profitability of the company which indicates business performance in the market (Rio
Tinto, 2018). Rio Tinto maintains a wealthy ratio of their operating profit which is 44%
on their sales and they are also getting a good return on their capital employee which is
pretty much high in the market. The company is able to maintain the rate of return 37%
on its capital employed which indicates that the company is performing its business
activities in a suitable manner.
 Liquidity Ratio – Liquidity ratio provides details related to the liquidity status of the
company in the market. This ratio helps management in the identification of capability of
the company to meet out their short term liability in the market. Quick ratio for the
company is 1.58 which means they are more ever capable to satisfy their short term
liability and a current ratio of the company is 1.91 which is higher than 1.33. This data
indicates the favourable condition of the company.
 Efficiency Ratio – Efficiency ratio provides the effectiveness of the business and their
operational activities in the market. Rio Tinto is able to maintain the Stock turnover
period for 47 Days and debtor collection period for 45. This data indicates that company
is very much effective in their business activities as the debts collection period of the
market is also 45 days and company maintain their debts so that they are able to justify
their working capital; requirement.
 Gearing Ratio – Further in the ratio analysis gearing ratio are calculated which identified
the Impact of financial cost on the financial performance of the company and also helps
in identifying the debts recovery capability of the company. For this, during the analysis,
the Gearing ratio and Interest coverage ratio are used which are 0.61 and 32.97 for Rio
Tinto. This financial data indicates a healthy performance of the company in their debts
fund and also adequate financial cost impact on the profitability of the company.
8

This financial ratio indicates the appropriate financial performance of the company in the
market. Rio Tinto is capable to maintain their debts funding and financial cost of borrowing
from the market (Robinson et al., 2015). Further, the profitability ratio indicates that the
company is very well managing their profitability in their operational activities. Rio Tinto
also manages their cash and cash equivalent assets for cope up with short time liability of the
company so that they can maintain their liquidity status in the company’s business process.
The entire financial ratio indicates the favourable position of the company in all aspects and
also indicates comprehensive growth in the market but some of the non-financial factors can
impact on the performance of the company which management need to consider prior making
any strategic decision.

9

References:
 Chen, G.G., Weikart, L.A. and Williams, D.W., 2014. Budget tools: Financial methods in
the public sector. CQ Press.
 Fullerton, R.R., Kennedy, F.A. and Widener, S.K., 2013. Management accounting and
control practices in a lean manufacturing environment. Accounting, Organizations and
Society, 38(1), pp.50-71.
 Rio Tinto, 2018, Annual Report, [Online], Riotinto, Available at:
http://www.riotinto.com/documents/RT_2018_annual_report.pdf [Accessed on 17.06.2019]
 Tappura, S., Sievänen, M., Heikkilä, J., Jussila, A. and Nenonen, N., 2015. A
management accounting perspective on safety. Safety science, 71, pp.151-159.
10

Appendix
1.
11

2.
12