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    Absorption Costing vs. Marginal Costing

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    prasannamrudula
    The document discusses the differences between marginal costing and absorption costing. Marginal costing only includes variable costs when determining the cost per unit of a product, while absorption costing includes both variable and fixed costs. Absorption costing is useful for pricing products as it incorporates total costs. Marginal costing is more useful for short-term decision making and planning, as it treats fixed costs as period costs rather than allocating them to each unit. The net profit shown under each method may differ depending on how fixed costs are treated. A numerical example is provided to illustrate the different profit calculations under marginal and absorption costing.

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    Absorption Costing vs. Marginal Costing

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    prasannamrudula
    2K views4 pages
    The document discusses the differences between marginal costing and absorption costing. Marginal costing only includes variable costs when determining the cost per unit of a product, while absorption costing includes both variable and fixed costs. Absorption costing is useful for pricing products as it incorporates total costs. Marginal costing is more useful for short-term decision making and planning, as it treats fixed costs as period costs rather than allocating them to each unit. The net profit shown under each method may differ depending on how fixed costs are treated. A numerical example is provided to illustrate the different profit calculations under marginal and absorption costing.

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    The document discusses the differences between marginal costing and absorption costing. Marginal costing only includes variable costs when determining the cost per unit of a product, while absorption costing includes both variable and fixed costs. Absorption costing is useful for pricing products as it incorporates total costs. Marginal costing is more useful for short-term decision making and planning, as it treats fixed costs as period costs rather than allocating them to each unit. The net profit shown under each method may differ depending on how fixed costs are treated. A numerical example is provided to illustrate the different profit calculations under marginal and absorption costing.

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    Attribution Non-Commercial (BY-NC)
    Download as DOC, PDF, TXT or read online from Scribd
    Download as doc, pdf, or txt
    2K views4 pages

    Absorption Costing vs. Marginal Costing

    Uploaded by

    prasannamrudula
    The document discusses the differences between marginal costing and absorption costing. Marginal costing only includes variable costs when determining the cost per unit of a product, while absorption costing includes both variable and fixed costs. Absorption costing is useful for pricing products as it incorporates total costs. Marginal costing is more useful for short-term decision making and planning, as it treats fixed costs as period costs rather than allocating them to each unit. The net profit shown under each method may differ depending on how fixed costs are treated. A numerical example is provided to illustrate the different profit calculations under marginal and absorption costing.

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    You are on page 1of 4

    MARGINAL COSTING VS.

    ABSORPTION COSTING:
    A PARCTICAL PERESPECTIVE
    P. K. Sikdar, Sr. Faculty EIRC of ICWAI

    Marginal costing is also termed as variable costing, a technique of costing which includes
    only variable manufacturing costs , in the form of direct materials, direct labour, and variable
    manufacturing overheads while determining the cost per unit of a product. Where as
    Absorption costing, is a costing technique that includes all manufacturing costs, in the form
    of direct materials, direct labour, and both variable and fixed manufacturing overheads, while
    determining the cost per unit of a product. It is also referred to as the full- cost technique.

    In the costing of product/service, a marginal costing technique considers the behavioural


    characteristics of costs (segregations of costs into fixed and variable elements), because per
    unit variable cost is fixed and total costs are variable in nature, where as total fixed costs are
    fixed and per unit fixed cost is variable in nature and furthermore variable costs are
    controllable in nature, while total fixed costs are un-controllable in nature. Marginal costing
    is useful for short-term planning, control and decision-making, particularly in a business
    where multi-products are produced. In marginal costing technique, the contribution is
    calculated after deducting variable costs from sales value with reference to each product or
    service, in order to calculate the total contribution from all products/services which are made
    towards the total fixed costs incurred by the business. As the fixed costs are treated as period
    costs, are deducted from total contribution to arrive at net profit.
    In the context of costing of a product/service, an absorption costing considers a share of all
    costs incurred by a business to each of its products/services. In absorption costing technique;
    costs are classified according to their functions. The gross profit is calculated after deducting
    production costs from sales and from gross profit, costs incurred in relation to other business
    functions are deducted to arrive at the net profit.
    Absorption costing gives better information for pricing products as it includes both variable
    and fixed costs.
    Marginal costing may lead to lower prices being offered if the firm is operating below
    capacity. Customers may still expect these lower prices as demand/capacity increases.

    Profit Statements under Marginal and Absorption Costing:


    The net profit shown by marginal costing and absorption costing techniques may not be the
    same due to the different treatment of fixed manufacturing overheads. Marginal costing
    technique treats fixed manufacturing overheads as period costs, where as in absorption
    costing technique these are absorbed into the cost of goods produced and are only charged
    against profit in the period in which those goods are sold. In absorption costing income
    statement, adjustment pertaining to under or over-absorption of overheads is also made to
    arrive at the profit.

    Terms explained:

    Product and Period Costs:

    Page 1 of 4
    1 Product costs: the costs of manufacturing the products;
    2 Period costs: these are the costs other than product costs that are charged to, debited to, or
    written off to the income statement each period.

    A Case Example on Marginal and Absorption Costing:


    Data for a Quarter for a manufacturing company:—

    Level of Activity 60% 100%


    Sales and Production(Units) 36,000 60,000
    Rs. (’000) Rs. (’000)
    Sales 432 720
    Production costs :
    (Variable and fixed) 366 510
    Sales, distribution and administration costs
    (Variable and fixed) 126 150

    The normal level of activity for the current year is 60,000 units, and fixed costs are incurred
    evenly throughout the year.
    There were no stocks of the product at the start of the quarter, in which 16,500 units were
    made and 13,500 units were sold. Actual fixed costs were the same as budgeted.
    Then, various calculations regarding Absorption vs. Marginal costing can be worked out as
    under:—
    Production Sales etc
    Costs (Rs.) costs (Rs.)
    Total costs of 60,000 units 5,10,000 1,50,000
    (fixed plus variable)
    Total costs of 36,000 units 3,66,000 1,26,000
    (fixed plus variable)
    Difference = variable costs of 24,000 units 1,44,000 24,000
    Variable costs per unit Rs.6 Re.1
    Production Sales etc.
    Costs (Rs.) Costs (Rs.)
    Total costs of 60,000 units 5,10,000 1,50,000
    Variable costs of 60,000 units 3,60,000 60,000
    Fixed costs 1,50,000 90,000
    The rate of absorption of fixed production overheads will therefore be:
    Rs.1,50,000 ÷ 60,000 = Rs. 2.50 per unit.
    (i) The fixed production overhead absorbed by the products would be 16,500 units
    produced × Rs. 2.50 = Rs. 41,250
    (ii) Budgeted annual fixed production overhead = Rs.1,50,000
    Rs.
    Actual quarterly fixed production overhead = budgeted quarterly fixed 37,50
    production overhead (1,50,000 ÷ 4) 0
    Production overhead absorbed into production [see (i) above] 41,25
    Page 2 of 4
    0
    Over -absorption of fixed production overhead 3,750

    Page 3 of 4
    (iii) (a) Profit statement for the quarter, using Absorption Costing
    Rs. Rs. Rs.
    Sales (13,500× Rs.12) 1,62,000
    Costs of production (no opening stocks)
    Value of stocks produced (16,500 × Rs. 8.50) 1,40,250
    Less value of closing stock
    (3,000 units × full production cost of Rs. 8.50) (25,500)
    1,14,750
    Sales etc costs
    Variable (13,500 × Re. 1) 13,500
    Fixed (1/4 of Rs. 90,000) 22,500
    36,000
    Total cost of sales 1,50,750
    Less over-absorbed production overhead 3,750
    1,47,000
    Profit 15,000

    (b) Profit statement for the quarter using Marginal Costing


    Rs. Rs.
    Sales (13,500×Rs.12) 1,62,000
    Variable costs of production (16,500 × Rs. 6) 99,000
    Less value of closing stocks (3,000 × Rs. 6) 18,000
    Variable production cost of sales 81,000
    Variable sales etc. costs (13,500 × Re.1) 13,500
    Total variable cost of sales (13,500 × Rs. 7) 94,500
    Contribution (13,500 × Rs. 5) 67,500
    Fixed Costs: Production 37,500
    Sales etc. 22,500
    60,000
    Profit 7,500

    Conclusion: Hence, Profits as shown by Marginal and Absorption Costing techniques are not
    the same, due to the reasons explained above.

    Page 4 of 4

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