Question

What will be the difference in net earnings computed using direct costing as opposed to absorption costing if the ending inventory increases with respect to the beginning inventory in terms of units?

• A. There will be no difference in net earnings.
• B. Net earnings computed using direct costing will be higher.
• C. The difference in net earnings cannot be determined from the information given.
• D. Net earnings computed using direct costing will be lower.

Answer 1

Answer: (D)

Net earnings computed using direct costing will be lower.

Below examples can be referred to understand the given situation. No. of units produced 600, no of units sold 450, no opening inventory.

Under Marginal/Direct Costing Under absorption Costing

No. Of Units sold 450 450

Sales @ Rs.8 Per Units Rs.3600 Rs.3600

Variable Cost @ Rs.5 P/U Rs.2250 Rs.2250

Fixed Cost Rs. 900 Rs, 675 *

Profit Rs.450 Rs.675

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* Fixed Cost Rs.900 for 600 units. Proportionate Fixed cost for 450 units Rs.900/600*450 i.e Rs.675.

It is evident that lower profit is reported under marginal/direct costing method if ending inventory is higher than the opening inventory.