A business produced 10,000 units and sold 9,000 units, with no opening inventory. Fixed production overheads were £50,000 for the period. By how much does the profit under absorption costing differ from the profit under marginal costing?
Answer and explanation
Correct answer: D. Absorption costing profit is £5,000 higher
- Step 1: Fixed overhead absorbed per unit = £50,000 / 10,000 = £5.
- Step 2: The 1,000 units of closing inventory carry £5,000 of fixed overhead forward under absorption costing.
- Step 3: Absorption costing therefore charges £5,000 less fixed overhead to the period, so its profit is £5,000 higher.
Answer
Absorption costing profit is £5,000 higher.
Why not the others: Absorption profit would be lower only if inventory had fallen. £50,000 would mean all fixed overhead was deferred, but only the closing inventory's share is. The profits differ whenever inventory levels change.
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