Study guide
12.2 Operating Statements & Profit Reconciliations
ACCA Applied Knowledge — Management Accounting MA
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1 Chapter 1: Nature, Purpose & Source of Management Information
1.1 Role of Management Accounting, Planning Levels & Information Quality 1.2 Sources of Data, Big Data & Data Capture Costs 1.3 Cost Classification, Cost Behaviour & Coding Systems
2 Chapter 2: Cost Centres, Cost Units & Presenting Information
2.1 Cost Objects, Responsibility Centres & Managerial Needs 2.2 Presenting Management Information & Visualisation
3 Chapter 3: Sampling Methods, Statistical Summaries & Spreadsheets
3.1 Sampling Methods & Practical Selection 3.2 Data Summarisation, Dispersion & Probability in Decisions 3.3 Normal Distribution & Spreadsheet Applications in Accounting
4 Chapter 4: Forecasting Techniques, Time Series & Index Numbers
4.1 Linear Functions & The High-Low Method 4.2 Correlation, Linear Regression & Product Life Cycle 4.3 Time Series Analysis & Index Numbers
5 Chapter 5: Accounting for Materials & Inventory Control
5.1 Material Procedures, Physical Control & Inventory Valuation 5.2 Economic Order Quantity & Bulk Purchase Discounts 5.3 Economic Batch Quantity & Inventory Reorder Levels
6 Chapter 6: Accounting for Labour & Overhead Costs
6.1 Accounting for Labour, Remuneration Systems & Labour Ratios 6.2 Overhead Allocation, Apportionment & Reciprocal Reapportionment 6.3 Overhead Absorption Rates & Under/Over Absorption
7 Chapter 7: Marginal Costing & Absorption Costing
7.1 Marginal Costing, Contribution & Cost-Volume-Profit Analysis 7.2 Profit Comparison & Reconciliation Between Absorption and Marginal Costing
8 Chapter 8: Costing Methods & Alternative Principles
8.1 Job Costing, Batch Costing & Service/Operation Costing 8.2 Process Costing, Losses, Gains & Joint/By-Products 8.3 Alternative Cost Accounting: ABC, Target Costing & Life-Cycle Costing
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10 Chapter 10: Flexible Budgets & Capital Investment Appraisal
10.1 Flexible Budgets & Budgetary Control Reporting 10.2 Capital Expenditure, Compounding & Discounting Fundamentals 10.3 Discounted Cash Flow: NPV, IRR & Payback Methods
11 Chapter 11: Standard Costing & Basic Cost Variances
11.1 Standard Costing Purpose, Principles & Standard Cost Cards 11.2 Sales Price, Sales Volume & Direct Material Variances 11.3 Direct Labour & Overhead Variances
12 Chapter 12: Variance Investigation & Operating Statements
12.1 Variance Investigation, Interrelationships & Reverse Calculations 12.2 Operating Statements & Profit Reconciliations
13 Chapter 13: Performance Measurement Framework & Financial Analysis
13.1 Mission Statements, Objectives & Contextual Influences 13.2 Financial Performance: Profitability & Operating Efficiency Ratios 13.3 Financial Performance: Liquidity & Financial Gearing Ratios
14 Chapter 14: Divisional Performance, Multidimensional Models & Quality
14.1 Divisional Performance: Return on Investment & Residual Income 14.2 The Balanced Scorecard, Critical Success Factors & KPIs 14.3 Value for Money (3Es), Resource Utilisation & Non-Profit Performance 14.4 Quality Management, Benchmarking, Cost Control & Cost Reduction
12.2 Operating Statements & Profit Reconciliations
Key Takeaways Explain This Topic AI
An operating statement reconciles budgeted profit or contribution to actual profit by systematically detailing individual sales variances, variable cost variances, and fixed overhead variances.
Under Standard Absorption Costing, the statement starts with Budgeted Profit, computes the Sales Volume Variance using the Standard Profit Margin, and reconciles all cost variances including Fixed Overhead Volume Variance.
Under Standard Marginal Costing, the statement starts with Budgeted Contribution, computes the Sales Volume Variance using the Standard Contribution Margin, and deducts actual fixed overheads without calculating a volume variance.
Fixed Overhead Volume Variance does not exist under Marginal Costing because fixed production overheads are treated as period costs written off in full rather than absorbed into unit inventory valuations.
The difference between reported Absorption Costing profit and Marginal Costing profit is strictly explained by the change in inventory levels multiplied by the standard fixed overhead absorption rate per unit.
Last updated: September 2026
Operating Statements & Profit Reconciliations
Core Principle: An operating statement is the definitive management accounting report that bridges budgeted operational performance to actual financial outcomes. Under standard costing, it transforms abstract variance metrics into an integrated, transparent profit reconciliation. The architectural layout of an operating statement depends fundamentally on whether the entity operates Standard Absorption Costing (reconciling Budgeted Profit using standard profit margins and absorbing fixed overheads) or Standard Marginal Costing (reconciling Budgeted Contribution using standard contribution margins and expensing fixed overheads as period costs).
1. The Role and Architectural Purpose of Operating Statements
Modern enterprises do not simply present an actual Statement of Profit or Loss to executive leadership. Without context, knowing that actual profit was $81,541 when budgeted profit was $80,000 does not tell management how or why that result materialized.
An Operating Statement provides the bridge between plan and reality:
Management by Exception in Action: Categorizes deviations into distinct functional accountabilities: commercial pricing, sales volume throughput, procurement prices, manufacturing efficiency, and overhead spending.
Diagnostic Transparency: Clarifies whether higher profit arose from genuine operational excellence or if external sales price increases masked severe internal factory waste.
Costing System Alignment: Reflects the fundamental cost accounting philosophy of the firm—reconciling either to gross profit under Absorption Costing (AC) or to contribution and net profit under Marginal Costing (MC).
2. Standard Absorption Costing Operating Statement
Under Standard Absorption Costing (AC) , product units absorb direct materials, direct labour, variable overheads, and a share of budgeted fixed production overheads via the predetermined Fixed Overhead Absorption Rate (FOAR) .
Architectural Structure (Absorption Costing)
Budgeted Profit: Budgeted Sales Volume × \times × Standard Profit per unit.
Sales Variances:
Sales Price Variance: A Q sold × ( A P − S P ) AQ_{\text{sold}} \times (AP - SP) A Q sold × ( A P − SP )
Sales Volume Profit Variance: ( A Q sold − B Q ) × Standard Profit Margin per unit (AQ_{\text{sold}} - BQ) \times \text{Standard Profit Margin per unit} ( A Q sold − BQ ) × Standard Profit Margin per unit
Intermediate Subtotal = Standard Profit on Actual Sales: Represents the profit the company should have made on the actual volume sold at actual selling prices, assuming standard cost efficiency.
Cost Variances (Categorized & Subtotaled):
Direct Materials: Price Variance and Usage Variance.
Direct Labour: Rate Variance, Efficiency Variance, and Idle Time Variance.
Variable Overhead: Expenditure Variance and Efficiency Variance.
Fixed Production Overhead:
Expenditure Variance: Budgeted Fixed Overhead − - − Actual Fixed Overhead.
Volume Variance: ( Actual Output − Budgeted Output ) × FOAR per unit (\text{Actual Output} - \text{Budgeted Output}) \times \text{FOAR per unit} ( Actual Output − Budgeted Output ) × FOAR per unit .
Subdivided into Capacity Variance [ ( A H − B H ) × FOAR per hour ] [(AH - BH) \times \text{FOAR per hour}] [( A H − B H ) × FOAR per hour ] and Efficiency Variance [ ( S H − A H ) × FOAR per hour ] [(SH - AH) \times \text{FOAR per hour}] [( S H − A H ) × FOAR per hour ] .
Reconciled Bottom Line = Actual Profit.
The Absorption Costing Under/Over Absorption Identity
In an Absorption Costing Operating Statement, the combined sum of the Fixed Overhead Expenditure Variance and the Fixed Overhead Volume Variance exactly equals the net under- or over-absorption of fixed overheads for the period: Under/Over Absorption = Fixed Overhead Expenditure Variance + Fixed Overhead Volume Variance \text{Under/Over Absorption} = \text{Fixed Overhead Expenditure Variance} + \text{Fixed Overhead Volume Variance} Under/Over Absorption = Fixed Overhead Expenditure Variance + Fixed Overhead Volume Variance Under/Over Absorption = Fixed Overhead Absorbed − Actual Fixed Overhead Incurred \text{Under/Over Absorption} = \text{Fixed Overhead Absorbed} - \text{Actual Fixed Overhead Incurred} Under/Over Absorption = Fixed Overhead Absorbed − Actual Fixed Overhead Incurred
3. Standard Marginal Costing Operating Statement
Under Standard Marginal Costing (MC) , product costs include only variable production costs . Fixed production overheads are treated strictly as period costs written off in full against contribution in the period incurred.
Architectural Structure (Marginal Costing)
Budgeted Contribution: Budgeted Sales Volume × \times × Standard Contribution per unit.
Sales Variances:
Sales Price Variance: A Q sold × ( A P − S P ) AQ_{\text{sold}} \times (AP - SP) A Q sold × ( A P − SP )
Sales Volume Contribution Variance: ( A Q sold − B Q ) × Standard Contribution Margin per unit (AQ_{\text{sold}} - BQ) \times \text{Standard Contribution Margin per unit} ( A Q sold − BQ ) × Standard Contribution Margin per unit
Intermediate Subtotal = Standard Contribution on Actual Sales.
Variable Cost Variances:
Direct Material Price & Usage Variances.
Direct Labour Rate, Efficiency & Idle Time Variances.
Variable Overhead Expenditure & Efficiency Variances.
Intermediate Subtotal = Actual Contribution.
Fixed Overhead Expenditure:
Less: Budgeted Fixed Production Overhead.
Adjust: Fixed Overhead Expenditure Variance ( Budgeted − Actual ) (\text{Budgeted} - \text{Actual}) ( Budgeted − Actual ) .
(Which nets to deducting Total Actual Fixed Overhead Incurred).
Reconciled Bottom Line = Actual Profit.
Caution
The Golden Rule of Marginal Costing: The Fixed Overhead Volume Variance DOES NOT EXIST in Marginal Costing.
Why? Because marginal costing does not absorb fixed overhead into unit costs or inventory valuations. Changes in production volume do not alter the fixed overhead charged to profit—the entire actual fixed expenditure is expensed in full. Therefore, calculating a fixed overhead volume variance in marginal costing is a fundamental accounting error.
4. Comprehensive Side-by-Side Worked Numerical Case Study
To master the differences between the two formats, we analyze the exact same operating data for Aethelgard Manufacturing Ltd under both Absorption Costing and Marginal Costing.
4.1 Master Operational Data: Product Valo
- Cost Element Standard Input per Unit Standard Rate / Price Standard Cost per Unit
- Direct Materials 3.0 kg $6.00 per kg $18.00
- Direct Labour 2.0 hours $14.00 per hour $28.00
- Variable Overhead 2.0 hours $4.00 per hour $8.00
- Standard Variable Cost $54.00
- Fixed Overhead 2.0 hours $5.00 per hour $10.00
- Standard Absorption Cost $64.00
- Standard Selling Price $80.00
Standard Contribution ( $ 80.00 − $ 54.00 ) (\text{\textdollar}80.00 - \text{\textdollar}54.00) ( $ 80.00 − $ 54.00 ) $26.00 per unit
Standard Profit Margin ( $ 80.00 − $ 64.00 ) (\text{\textdollar}80.00 - \text{\textdollar}64.00) ( $ 80.00 − $ 64.00 ) $16.00 per unit
- Budgeted Parameters (Month of October)
- Budgeted Production: 5,000 units (10,000 standard labour hours)
- Budgeted Sales: 5,000 units
Budgeted Fixed Overhead: 5 , 000 units × $ 10.00 = $ 50 , 000 5,000 \text{ units} \times \text{\textdollar}10.00 = \mathbf{\text{\textdollar}50,000} 5 , 000 units × $ 10.00 = $ 50 , 000
Budgeted Profit (AC): 5 , 000 units × $ 16.00 = $ 80 , 000 5,000 \text{ units} \times \text{\textdollar}16.00 = \mathbf{\text{\textdollar}80,000} 5 , 000 units × $ 16.00 = $ 80 , 000
Budgeted Contribution (MC): 5 , 000 units × $ 26.00 = $ 130 , 000 5,000 \text{ units} \times \text{\textdollar}26.00 = \mathbf{\text{\textdollar}130,000} 5 , 000 units × $ 26.00 = $ 130 , 000
- Actual Operating Results (Month of October)
- Actual Production: 5,400 units
- Actual Sales: 4,800 units at an average selling price of $82.00 per unit
- Opening Inventory: Nil
Closing Inventory: 5 , 400 produced − 4 , 800 sold = 600 units 5,400 \text{ produced} - 4,800 \text{ sold} = \mathbf{600 \text{ units}} 5 , 400 produced − 4 , 800 sold = 600 units
- Direct Materials Purchased & Consumed: 16,740 kg costing $97,092 (actual price = $5.80/kg)
- Direct Labour Incurred: 11,070 hours worked and paid, costing $157,194 (actual rate = $14.20/hr)
- Variable Production Overhead Incurred: $43,173
- Fixed Production Overhead Incurred: $53,000
- 4.2 Detailed Calculation of All Individual Variances
Sales Price Variance: A Q sold × ( A P − S P ) = 4 , 800 × ( $ 82.00 − $ 80.00 ) = $ 9 , 600 Favorable AQ_{\text{sold}} \times (AP - SP) = 4,800 \times (\$82.00 - \$80.00) = \mathbf{\$9,600 \text{ Favorable}} A Q sold × ( A P − SP ) = 4 , 800 × ( $82.00 − $80.00 ) = $9 , 600 Favorable
Sales Volume Variance:
Absorption Costing (Profit Basis): ( A Q sold − B Q ) × Standard Profit = ( 4 , 800 − 5 , 000 ) × $ 16.00 = $ 3 , 200 Adverse (AQ_{\text{sold}} - BQ) \times \text{Standard Profit} = (4,800 - 5,000) \times \$16.00 = \mathbf{\$3,200 \text{ Adverse}} ( A Q sold − BQ ) × Standard Profit = ( 4 , 800 − 5 , 000 ) × $16.00 = $3 , 200 Adverse
Marginal Costing (Contribution Basis): ( A Q sold − B Q ) × Standard Contribution = ( 4 , 800 − 5 , 000 ) × $ 26.00 = $ 5 , 200 Adverse (AQ_{\text{sold}} - BQ) \times \text{Standard Contribution} = (4,800 - 5,000) \times \$26.00 = \mathbf{\$5,200 \text{ Adverse}} ( A Q sold − BQ ) × Standard Contribution = ( 4 , 800 − 5 , 000 ) × $26.00 = $5 , 200 Adverse
Direct Material Variances:
Standard quantity for actual production ( S Q SQ SQ ): 5 , 400 units × 3.0 kg = 16 , 200 kg 5,400 \text{ units} \times 3.0 \text{ kg} = 16,200 \text{ kg} 5 , 400 units × 3.0 kg = 16 , 200 kg
Material Price Variance: 16 , 740 kg × ( $ 6.00 − $ 5.80 ) = $ 3 , 348 Favorable 16,740 \text{ kg} \times (\text{\textdollar}6.00 - \text{\textdollar}5.80) = \mathbf{\text{\textdollar}3,348 \text{ Favorable}} 16 , 740 kg × ( $ 6.00 − $ 5.80 ) = $ 3 , 348 Favorable
Material Usage Variance: ( 16 , 200 − 16 , 740 ) × $ 6.00 = − 540 × $ 6.00 = $ 3 , 240 Adverse (16,200 - 16,740) \times \text{\textdollar}6.00 = -540 \times \text{\textdollar}6.00 = \mathbf{\text{\textdollar}3,240 \text{ Adverse}} ( 16 , 200 − 16 , 740 ) × $ 6.00 = − 540 × $ 6.00 = $ 3 , 240 Adverse
Direct Labour Variances:
Standard hours for actual production ( S H SH S H ): 5 , 400 units × 2.0 hrs = 10 , 800 hours 5,400 \text{ units} \times 2.0 \text{ hrs} = 10,800 \text{ hours} 5 , 400 units × 2.0 hrs = 10 , 800 hours
Labour Rate Variance: 11 , 070 hrs × ( $ 14.00 − $ 14.20 ) = $ 2 , 214 Adverse 11,070 \text{ hrs} \times (\text{\textdollar}14.00 - \text{\textdollar}14.20) = \mathbf{\text{\textdollar}2,214 \text{ Adverse}} 11 , 070 hrs × ( $ 14.00 − $ 14.20 ) = $ 2 , 214 Adverse
Labour Efficiency Variance: ( 10 , 800 − 11 , 070 ) × $ 14.00 = − 270 × $ 14.00 = $ 3 , 780 Adverse (10,800 - 11,070) \times \text{\textdollar}14.00 = -270 \times \text{\textdollar}14.00 = \mathbf{\text{\textdollar}3,780 \text{ Adverse}} ( 10 , 800 − 11 , 070 ) × $ 14.00 = − 270 × $ 14.00 = $ 3 , 780 Adverse
Variable Overhead Variances:
Variable Overhead Expenditure Variance: ( 11 , 070 actual hrs × $ 4.00 ) − $ 43 , 173 = $ 44 , 280 − $ 43 , 173 = $ 1 , 107 Favorable (11,070 \text{ actual hrs} \times \text{\textdollar}4.00) - \text{\textdollar}43,173 = \text{\textdollar}44,280 - \text{\textdollar}43,173 = \mathbf{\text{\textdollar}1,107 \text{ Favorable}} ( 11 , 070 actual hrs × $ 4.00 ) − $ 43 , 173 = $ 44 , 280 − $ 43 , 173 = $ 1 , 107 Favorable
Variable Overhead Efficiency Variance: ( 10 , 800 std hrs − 11 , 070 actual hrs ) × $ 4.00 = $ 1 , 080 Adverse (10,800 \text{ std hrs} - 11,070 \text{ actual hrs}) \times \text{\textdollar}4.00 = \mathbf{\text{\textdollar}1,080 \text{ Adverse}} ( 10 , 800 std hrs − 11 , 070 actual hrs ) × $ 4.00 = $ 1 , 080 Adverse
Fixed Production Overhead Variances:
Fixed Overhead Expenditure Variance: Budgeted − Actual = $ 50 , 000 − $ 53 , 000 = $ 3 , 000 Adverse \text{Budgeted} - \text{Actual} = \text{\textdollar}50,000 - \text{\textdollar}53,000 = \mathbf{\text{\textdollar}3,000 \text{ Adverse}} Budgeted − Actual = $ 50 , 000 − $ 53 , 000 = $ 3 , 000 Adverse
Fixed Overhead Volume Variance (AC Only): ( Actual Production − Budgeted Production ) × FOAR per unit (\text{Actual Production} - \text{Budgeted Production}) \times \text{FOAR per unit} ( Actual Production − Budgeted Production ) × FOAR per unit ( 5 , 400 − 5 , 000 ) × $ 10.00 = $ 4 , 000 Favorable (5,400 - 5,000) \times \$10.00 = \mathbf{\$4,000 \text{ Favorable}} ( 5 , 400 − 5 , 000 ) × $10.00 = $4 , 000 Favorable
Volume Breakdown:
Capacity Variance: ( 11 , 070 actual hrs − 10 , 000 budgeted hrs ) × $ 5.00 / hr = $ 5 , 350 F (11,070 \text{ actual hrs} - 10,000 \text{ budgeted hrs}) \times \text{\textdollar}5.00/\text{hr} = \mathbf{\text{\textdollar}5,350 \text{ F}} ( 11 , 070 actual hrs − 10 , 000 budgeted hrs ) × $ 5.00/ hr = $ 5 , 350 F
Efficiency Variance: ( 10 , 800 std hrs − 11 , 070 actual hrs ) × $ 5.00 / hr = $ 1 , 350 A (10,800 \text{ std hrs} - 11,070 \text{ actual hrs}) \times \text{\textdollar}5.00/\text{hr} = \mathbf{\text{\textdollar}1,350 \text{ A}} ( 10 , 800 std hrs − 11 , 070 actual hrs ) × $ 5.00/ hr = $ 1 , 350 A
Net Volume Variance: $ 5 , 350 F − $ 1 , 350 A = $ 4 , 000 F \text{\textdollar}5,350 \text{ F} - \text{\textdollar}1,350 \text{ A} = \mathbf{\text{\textdollar}4,000 \text{ F}} $ 5 , 350 F − $ 1 , 350 A = $ 4 , 000 F
- 4.3 Standard Absorption Costing Operating Statement Aethelgard Manufacturing Ltd
- Operating Statement (Absorption Costing) for the Month of October
- ─────────────────────────────────────────────────────────────────────────────
- Budgeted Profit (5,000 units @ $16.00) $80,000
- Sales Variances: Favorable Adverse
- Sales Price Variance $9,600
- Sales Volume Profit Variance $3,200
- ────────── ──────────
- Net Sales Variance $9,600 $3,200 $6,400 F
- ─────────────────────────────────────────────────────────────────────────────
- Standard Profit on Actual Sales $86,400
- Cost Variances: Favorable Adverse
- Direct Material Price $3,348
- Direct Material Usage $3,240
- Direct Labour Rate $2,214
- Direct Labour Efficiency $3,780
- Variable Overhead Expenditure $1,107
- Variable Overhead Efficiency $1,080
- Fixed Overhead Expenditure $3,000
- Fixed Overhead Volume $4,000
- ────────── ──────────
- Subtotals $8,455 $13,314
- Net Cost Variance ($4,859) A
- ─────────────────────────────────────────────────────────────────────────────
- Actual Profit $81,541
- ═════════════════════════════════════════════════════════════════════════════
Check from First Principles:
Actual Revenue ( 4 , 800 × $ 82 4,800 \times \text{\textdollar}82 4 , 800 × $ 82 ) = $393,600.
Standard Cost of Sales ( 4 , 800 × $ 64 4,800 \times \text{\textdollar}64 4 , 800 × $ 64 ) = $307,200.
Actual Cost of Sales = $307,200 + $4,859 (Net Adverse Cost Variance) = $312,059.
Actual Profit = $393,600 - $312,059 = $81,541 . Reconciles to the exact dollar.
- 4.4 Standard Marginal Costing Operating Statement Aethelgard Manufacturing Ltd
- Operating Statement (Marginal Costing) for the Month of October
- ─────────────────────────────────────────────────────────────────────────────
- Budgeted Contribution (5,000 units @ $26.00) $130,000
- Sales Variances: Favorable Adverse
- Sales Price Variance $9,600
- Sales Volume Contribution Variance $5,200
- ────────── ──────────
- Net Sales Variance $9,600 $5,200 $4,400 F
- ─────────────────────────────────────────────────────────────────────────────
- Standard Contribution on Actual Sales $134,400
- Variable Cost Variances: Favorable Adverse
- Direct Material Price $3,348
- Direct Material Usage $3,240
- Direct Labour Rate $2,214
- Direct Labour Efficiency $3,780
- Variable Overhead Expenditure $1,107
- Variable Overhead Efficiency $1,080
- ────────── ──────────
- Subtotals $4,455 $10,314
- Net Variable Cost Variance ($5,859) A
- ─────────────────────────────────────────────────────────────────────────────
- Actual Contribution $128,541
Fixed Overheads:
- Budgeted Fixed Overhead $50,000
- Fixed Overhead Expenditure Variance (Adverse) $3,000
- ──────────
- Less: Actual Fixed Overhead Incurred ($53,000)
- ─────────────────────────────────────────────────────────────────────────────
- Actual Profit $75,541
- ═════════════════════════════════════════════════════════════════════════════
Check from First Principles:
Actual Revenue = $393,600.
Standard Variable Cost of Sales ( 4 , 800 × $ 54 4,800 \times \text{\textdollar}54 4 , 800 × $ 54 ) = $259,200.
Actual Variable Cost of Sales = $259,200 + $5,859 = $265,059.
Actual Contribution = $393,600 - $265,059 = $128,541.
Less Actual Fixed Overhead ($53,000) = $75,541 . Reconciles to the exact dollar.
4.5 Formal Profit Reconciliation Between AC and MC
Why does Absorption Costing report an actual profit of $81,541 while Marginal Costing reports $75,541 ? Profit Difference = AC Profit − MC Profit = $ 81 , 541 − $ 75 , 541 = $ 6 , 000 \text{Profit Difference} = \text{AC Profit} - \text{MC Profit} = \$81,541 - \$75,541 = \mathbf{\$6,000} Profit Difference = AC Profit − MC Profit = $81 , 541 − $75 , 541 = $6 , 000 Reconciliation Formula = ( Closing Inventory − Opening Inventory ) × FOAR per unit \text{Reconciliation Formula} = (\text{Closing Inventory} - \text{Opening Inventory}) \times \text{FOAR per unit} Reconciliation Formula = ( Closing Inventory − Opening Inventory ) × FOAR per unit Change in Inventory = ( 600 units − 0 units ) = + 600 units \text{Change in Inventory} = (600 \text{ units} - 0 \text{ units}) = +600 \text{ units} Change in Inventory = ( 600 units − 0 units ) = + 600 units Reconciling Adjustment = + 600 units × $ 10.00 per unit = + $ 6 , 000 \text{Reconciling Adjustment} = +600 \text{ units} \times \$10.00 \text{ per unit} = \mathbf{+\$6,000} Reconciling Adjustment = + 600 units × $10.00 per unit = + $6 , 000 Absorption Costing Profit = Marginal Costing Profit + $ 6 , 000 = $ 75 , 541 + $ 6 , 000 = $ 81 , 541 \text{Absorption Costing Profit} = \text{Marginal Costing Profit} + \$6,000 = \$75,541 + \$6,000 = \mathbf{\$81,541} Absorption Costing Profit = Marginal Costing Profit + $6 , 000 = $75 , 541 + $6 , 000 = $81 , 541
Why Does the Difference Occur?
Because production (5,400 units) exceeded sales (4,800 units), 600 units entered closing inventory. Under Absorption Costing, each unit carries $10.00 of fixed overhead on the Statement of Financial Position ( 600 × $ 10 = $ 6 , 000 600 \times \text{\textdollar}10 = \text{\textdollar}6,000 600 × $ 10 = $ 6 , 000 ). This $6,000 of fixed overhead is deferred to future periods. Under Marginal Costing, the full $53,000 of fixed overhead was expensed immediately in October. Thus, AC profit is exactly $6,000 higher.
5. Comparative Structural Summary
- Analytical Feature Standard Absorption Costing Standard Marginal Costing
- Starting Metric Budgeted Profit Budgeted Contribution
- Sales Volume Valuation Standard Profit Margin per unit Standard Contribution Margin per unit
- Intermediate Subtotal Standard Profit on Actual Sales Standard Contribution on Actual Sales
Cost Variances Included Direct Material, Direct Labour, Variable O/H, Fixed O/H Expenditure & Volume Direct Material, Direct Labour, Variable O/H ( Variable Only )
Fixed Overhead Volume Variance Yes (Capacity + Efficiency) No (Strictly does not exist)
Deduction of Fixed Costs Included as individual cost variances Deducted in total (Budgeted ± \pm ± Expenditure Variance)
Closing Inventory Valuation Total production cost (includes fixed overhead) Variable cost only (excludes fixed overhead)
6. Exam Traps & Pitfalls in Operating Statements
The Sales Volume Variance Trap: Candidates constantly calculate the sales volume variance using the standard contribution margin in an absorption costing statement, or the standard profit margin in a marginal costing statement. Remember: AC reconciles profit (use Standard Profit Margin); MC reconciles contribution (use Standard Contribution Margin).
Inventing Fixed Overhead Volume Variances in Marginal Costing: Exam questions often provide fixed overhead capacity and efficiency data and ask for the marginal costing operating statement. Candidates who calculate and insert a fixed overhead volume variance lose full marks on that section.
Sign Placement in Operating Tables: Clearly label variances in separate "Favorable" and "Adverse" columns before determining the net adjustment. Inverting the sign of a net cost variance (e.g., adding an adverse cost variance to standard profit) is the most frequent computational error on the exam.
Inventory Reconciliation Direction: Always verify whether inventory increased or decreased. When Production > Sales \text{Production} > \text{Sales} Production > Sales , closing inventory rises, and AC Profit > MC Profit \text{AC Profit} > \text{MC Profit} AC Profit > MC Profit . When Sales > Production \text{Sales} > \text{Production} Sales > Production , inventory falls, and MC Profit > AC Profit \text{MC Profit} > \text{AC Profit} MC Profit > AC Profit .