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Revision question on marginal costing and absorption costing

Keypuzzle limited manufactures a novelty keyring which it sells to conference and event organisers. The keyring comprises a basic metal ring to attach keys and a wooden puzzle which was invented by the managing director and founder of the company, Paul Crean. Having successfully developed and patented the prototype of the keyring, the company commenced production in ennis five years ago. The manufacturing facility has a maximum production capacity of 500,000 keyrings, which is well in excess of current sales. The production director has advised Paul that “it doesn’t make sense not to use the available capacity to produce more keyrings as they will be sold over the coming years”. Consequently, over the past four years the company has produced more key rings than it has sold and has built up a substantial inventory.

for its management accounts the company uses variable (marginal) costing and Paul has raised concerns with the management accountant regarding the declining profit levels. It was agreed that the management accountant would prepare the management accounts for the current year and prior year using absorption costing, highlighting the differences compared to variable costing. unfortunately, the management accountant is ill and has not completed the absorption and variable cost comparison. Information that had been compiled relating to the comparison is shown below.

    Budgeted annual fixed production overhead 31 March 2016 €105,625 31 March 2015 €105,625
Sales (units) 350,000 319,500
Opening inventory (units) 19,500 18,000
Closing inventory (units) 22,000 19,500
Direct material (per unit)  
–  Steel ring @ €0.08
–  Varnished beech @ €0.12
Direct labour: 4 mins per unit @ €9 per hour
Variable overhead: 10% of direct labour cost

The keyring sells for €1.95. Direct material and direct labour costs have not increased over the two year period.

fixed production overheads are absorbed based on units of production assuming that the company is operating at 65% of its maximum capacity. The company’s actual annual fixed production overhead is equal to the budgeted amount.


(a)     Show the product cost for one keyring under variable (marginal) costing and absorption costing. 

(b)     Prepare management accounts for the year ending 31 March 2016 and 2015 showing profit calculated using: (i)       Variable (marginal) costing (ii)      Absorption costing  

(c)     reconcile the profit calculated at (b) (i) and (ii) above. 

(d)     from the perspective of Key Puzzle limited, outline TWO benefits and TWO limitations of using absorption costing.

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