Standard costing systems - Standard unit costs under margina...

Learning Outcomes

After reading this article, you will be able to explain the principles and purpose of standard costing systems, distinguish between standard unit costs calculated under marginal and absorption costing, and compute standard costs per unit for products and services. You will also identify the impact that cost classification has on inventory valuation and profit determination in accordance with typical ACCA exam requirements.

ACCA Management Accounting (MA) Syllabus

For ACCA Management Accounting (MA), you are required to understand standard costing systems and the calculation of standard costs under both marginal and absorption approaches. This article addresses:

• The role and purpose of standard costing within management accounting
• The distinction between marginal costing and absorption costing
• How to establish standard cost per unit under marginal and absorption costing
• The effect of standard costing systems on inventory valuation and reported profit
• Preparation of standard cost cards and the essential elements involved

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the essential difference between a standard cost under marginal costing and under absorption costing?
2. When preparing a standard cost card, which elements are included in marginal costing but not in absorption costing?
3. A company’s variable production overheads are $3 per unit and fixed production overheads are $5 per unit. How would these costs be treated under marginal and absorption costing, respectively, in the standard cost per unit?
4. True or false? Absorption costing includes all non-production overheads in product costs for inventory valuation.

Introduction

Standard costing provides management with predetermined, target costs for products and services. These targets allow for planning, cost control, and performance evaluation. The way a standard unit cost is calculated depends on whether a business uses marginal or absorption costing. Each approach includes different cost elements, which affects both inventory valuation and any profit figures reported for a period.

Understanding how to establish a standard cost per unit in both marginal and absorption costing is essential for budgeting, variance analysis, and financial reporting, as required by the ACCA syllabus.

Key Term: standard cost
The predetermined or target cost of a unit of product or service, calculated for control and comparison purposes with actual costs.

Standard Costing Systems

Standard costing systems involve setting expected costs for different resources used in production, such as materials, labour, and overheads. These standard costs become benchmarks for measuring actual performance and are critical in both marginal and absorption costing methods.

Calculating Standard Costs

The standard cost per unit is typically shown on a cost card. The card details the expected costs for each element incurred in producing a single unit.

Key Elements of a Standard Cost Card

• Direct materials: Quantity × Standard Price
• Direct labour: Hours × Standard Rate
• Production overheads: Allocation depends on costing method (detailed below)
• Non-production overheads: Included only in special management reports, not inventory valuation

Differences Between Marginal and Absorption Costing

The main distinction relates to treatment of fixed production overheads.

• Marginal costing includes only variable production costs in inventory and product costs.
• Absorption costing includes both variable and fixed production costs in product and inventory costs.

Key Term: marginal costing
A costing method that values product and inventory at variable (marginal) production costs only. Fixed production overheads are treated as a period cost and not included in the unit cost.

Key Term: absorption costing
A costing method where both variable and fixed production overheads are included in the cost of inventory and products. Fixed overheads are assigned to units using a pre-determined absorption rate.

Main Components Under Each Method

Worked Example 1.1

A company manufactures a single product. For one unit, the standard inputs are:

• Direct materials: 10 kg @ $4 per kg
• Direct labour: 2 hours @ $8 per hour
• Variable production overhead: $3 per unit
• Fixed production overhead (budgeted): $5 per unit (based on expected output of 10,000 units and a fixed overhead budget of $50,000).

Required: Calculate the standard cost per unit under marginal costing and absorption costing.

Answer:
Marginal costing:
Direct materials: 10 × $4 = $40
Direct labour: 2 × $8 = $16
Variable production overhead: $3
Standard marginal cost per unit = $59
Absorption costing:
Add fixed production overhead per unit: $5
Standard absorption cost per unit = $64

When to Use Marginal or Absorption Standard Costs

• Marginal costing is used for decision making, contribution analysis, and short-term management purposes.
• Absorption costing is needed for financial reporting and valuing inventory under IFRS and accounting standards.

Worked Example 1.2

A company uses a standard cost card for its main product. During the year, output is lower than expected, and not all budgeted fixed overhead is absorbed.

Question: What impact does this have on reported profit under marginal and absorption costing?

Answer:
Under marginal costing, all fixed production overhead is treated as a period expense, so profit is consistent regardless of inventory changes.
Under absorption costing, lower output means less fixed overhead is absorbed into inventory, so there may be under-absorption, causing reported profit to decrease compared to marginal costing.

Exam Warning

Take care not to include non-production overheads (such as administration, selling, or distribution expenses) when valuing inventory under either marginal or absorption costing. Only production costs are included.

Standard Cost Card Structure

The standard cost card sets out the unit cost breakdown clearly.

When preparing or interpreting a standard cost card, always check which costing method is being used.

Impact on Inventory Valuation and Profit

Inventory values and reported profits will differ between the two costing methods when production and sales volumes are not equal:

• If production > sales (inventory increases), absorption costing shows higher profit than marginal costing (some fixed overhead is carried forward in closing inventory).
• If sales > production (inventory decreases), absorption costing shows lower profit than marginal costing (fixed overhead from previous period is released to the statement of profit or loss).

Worked Example 1.3

Last month, a company produced 1,200 units and sold 1,000 units. The standard marginal cost per unit is $50; the fixed production overhead absorbed per unit is $10.

Required: Calculate the value of closing inventory under both methods.

Answer:
Units in closing inventory = 1,200 – 1,000 = 200 units
Marginal costing: 200 × $50 = $10,000
Absorption costing: 200 × ($50 + $10) = $12,000

Summary

• Standard costs represent expected costs per unit of output, used for planning, control, and variance analysis.
• Marginal costing uses variable (marginal) production costs only for inventory valuation. Absorption costing includes both variable and fixed production overheads.
• The way costs are treated changes both the value of closing inventory and period profit figures.
• A standard cost card provides a breakdown of all relevant cost elements per unit for each costing method.
• Understanding which costs are included under each method is critical for financial control and ACCA exam success.

Key Point Checklist

This article has covered the following key knowledge points:

• Distinguish between marginal and absorption costing in standard costing systems
• Identify which cost elements are included in standard cost per unit under each method
• Calculate standard cost per unit using a cost card format for both costing methods
• Recognize impacts on inventory valuation and reported profit from method chosen
• Understand the function of standard costing in planning and control

Key Terms and Concepts

• standard cost
• marginal costing
• absorption costing