CENTRE FOR DISTANCE AND ONLINE EDUCATION

CENTRE FOR DISTANCE AND ONLINE EDUCATION

Live Session – Session No. 2

MCOMC303 – Management Accounting

Unit No. 2: Marginal(or Variable) and Absorption Costing

M.Com. Semester-3
SURAJ AGARWAL
M.COM, M.B.A, UGC NET
(Qualified)
FACULTY CDOE, SMU
Learning Outcomes

1 2 3 4
Describe joint Describe the Distinguish between Know accounting
venture. features of joint joint ventures and treatment in joint
ventures. consignment sales. ventures.
Meaning of Marginal Costing
The accounting approach in which variable expenses are charged to cost units and fixed
expenses are written off in full against the aggregate contribution is known as marginal
costing. Marginal cost is the extra cost to generate one additional unit of output.
It is not a one-of-a-kind costing approach: Like contract costing, process costing, or
batch costing. However, marginal costing is a separate sort of
-making. It serves as a foundation for comprehending cost data to assess the profitability
of various goods, processes, and cost centers.
Decision Making: It plays an important part in decision-making because fluctuations in
the level of activity pose a major difficulty to the management of the endeavor. Marginal
costing supports managers in making end-of- product lifecycle choices such as machine
replacement, terminating a product or service, and so on. It also assists management in
determining the right level of activity through break-even analysis, which reflects the
impact of rising or reducing output level on the total profit of the organisation.
Characteristics of Marginal Costing:

•Classification into Fixed costs And Variable costs: Costs are classified
into fixed and variable costs based on their variability. Semi-variable costs
are split in the same way.
•Profitability: The contribution margin is used to determine
departmental and product profitability.
•Stock valuation: Only variable costs are included when evaluating
finished items and work in progress. Selling and distribution overheads,
on the other hand, are not factored into the inventory valuation.
•Price Determination: Prices are set based on marginal cost and
marginal contribution.
Variable costing

Variable costing is a concept used in management and cost accounting that excludes fixed manufacturing
overhead from the product cost of production. For example, Cost of goods sold (COGS), packaging,
commission, raw materials, wages, etc. This contrasts with absorption costing, which allocates fixed
production overhead to products produced Variable costing is not permitted in financial reporting under
accounting standards such as GAAP and IFRS. The basic variable costing involves direct labour, direct
materials, and so on.
Financial Reporting of Variable Costing:
Although accounting rules such as GAAP and IFRS ban the use of variable costing in financial reporting,
managers routinely utilize this costing approach to:
Conduct a break-even analysis to calculate the number of units required to start making a profit.
Determine a product's contribution margin to better comprehend the link between pricing, volume, and
profit.
Exclude fixed manufacturing overhead expenses, which might cause issues owing to how fixed costs are
assigned to each product, to make decision-making easier.
Features of Variable Costing:

Variable costing has the following features:

•Only variable manufacturing costs are used to derive product costs in variable costing.
•Fixed factory overhead is treated as a period expense and is charged against revenue in
the period in which it is incurred.
•Because fixed factory overhead is not included in the cost of production, the cost of
inventory is lower than absorption costing.
•Variable costing operational income fluctuates with sales rather than output.
•The Contribution Approach is used to calculate net income. C/M is calculated by
subtracting the variable cost of products sold from the sales, and net income is calculated
by subtracting all fixed expenses from C/M.
•In variable costing, there is no need to correct under or over-allotment of fixed factory
overhead because it is not included in the cost of production.
Example of Marginal Costing:

Mr. Abhishek produces and sells washing machines. In the first year
of business, he sells 10 washing machines for Rs 100000 which cost
him Rs 50000 to make. In the second year he sells and produces 15
washing machines for Rs 150000, which cost him Rs 75000 to make.
Calculate Marginal cost Marginal cost = Change in Total Price /
Change in quantity
Marginal Cost = (75000-50000)/ (15-10)
= 25000/5
= Rs 5000
Absorption Costing
Absorption costing is also known as complete costing since it covers all manufacturing expenses. Direct labour and
material expenses are examples of variable costs. Rent, security, and insurance are examples of fixed costs. Electricity
prices for the plant are among the semi-variable expenditures. Thus, with full costing, all expenses are absorbed by the
product, regardless of the goods sold.
Unlike variable costing, which examines just variable expenses, absorption costing allows for exact accounting for the
whole cost of manufacturing. The absorption costing approach allows for the reporting of a high profit with a high value
of closing inventory. This is because the production cost has been absorbed.
The absorption costing technique is provided in the generally recognized accounting standards (GAAP) for reporting
accounts under various legislation. The fixed cost per unit produced reduces with increasing output in this manner. In
contrast to variable costing, where incremental output carries the same variable costs of production, this is not the case.
Example of Absorption Costing:
A company produces 1000 units in the financial accounting period.
Each unit costs Rs. 20 for direct materials and Rs. 20 for direct labour. Manufacturing overhead was Rs.10 plus Rs. 7 in
variable administrative costs. Fixed manufacturing overhead was Rs. 100,950. Fixed administrative costs were Rs.
100,000. Absorption cost per unit formula
= (Direct Material Costs + Direct Labour Costs + Variable Manufacturing Overhead Costs + Fixed Manufacturing Overhead
Costs) / Number of units produced.
= (Rs. 20+Rs. 20+Rs. 10+Rs. 100,950 / 1000)
= Rs 101 per unit product cost
 Difference Between Marginal And Absorption
Costing
Absorption and Marginal Costing Definition: Absorption costing is a costing methodology in which all manufacturing
expenses, including va
riable and fixed costs, are classed as product costs, whereas marginal costing is a costing approach in which the marginal
cost is charged to units of cost while the fixed cost is written off against the contribution.
Costs associated with absorption and margin costs: In absorption costing, both variable and fixed expenses are
included in the product's price. In contrast, only variable expenses are treated as product costs in marginal costing,
whereas fixed expenses are categorized as period costs.
Per-unit Contribution: In marginal costing, contribution per unit is taken into account, but in absorption costing, net
profit per unit is taken into account.
Prices per unit: Major emphasis is given to the cost of each unit in absorption costing. However, under marginal
costing, the cost of generating the following unit is given top importance.
Recovery of overheads: Absorption costing stresses overhead recovery, whereas marginal costing stresses the
computation of each unit's contribution.
Overhead classification: Overheads are grouped into administrative, manufacturing, distribution, and selling
overheads in absorption costing. Overheads, on the other side, are divided into fixed and variable overheads in
marginal costing.
The impact on unit cost: The cost per unit in absorption costing is impacted by differences in the opening and closing
stock, but the cost per unit in marginal costing is unaffected by changes in the opening and closing stock.
GAAP conformity: While absorption costing is following GAAP, marginal costing is not.
 Profit reporting under Marginal Costing and Absorption Costing:
When there is Production but no Sales: In this situation, the income from absorption costing may represent profit
even if no sale has occurred. This is because fixed manufacturing overheads have absorbed more than normal
capacity output. However, because there are no sales, the variable income statement will show a loss. Even though no
sales were made, the income
the number of fixed production overheads that were not absorbed. Thus, profit under absorption costing is controlled by
a variety of elements such as the number of

When Production is Equal to Sales: Net income would be the same under absorption costing and marginal costing
methodologies when production and sales are equal, i.e., there is no opening or closing stock or when completed
products inventory does not move from period to period.

The following is a summary of the profit reported under marginal and costing.
If Production = Sales; Absorption profit = marginal costing profit.
If Production > Sales; Absorption profit > marginal costing profit.
If Production < Sales; Absorption profit < marginal costing profit.
If production fluctuates and sales are constant; absorption profit fluctuates and marginal costing profit is constant.
If production is constant and sales fluctuate, both profits vary in the direction of sales.
 INVENTORY VALUATION WITH MARGINAL AND ABSORPTION COSTING

Absorption costing covers both direct and indirect costs, whereas marginal costing is based on variable
expenses but excludes fixed expenses. In general, if a cost is variable, it is also direct; hence, adding fixed
overheads to the marginal cost yields the whole absorption cost.
Whenever there is a closing inventory, the profits estimated by the two approaches will differ. The variation
in profit will be explained by differences in closing inventory value. Marginal costing is not permitted in
financial reporting, although absorption costing is permitted in both management accounting and financial
accounting.
When inventory levels rise or fall over time, earnings vary according to absorption and marginal costs. When
inventory levels rise, absorption costs yield a bigger profit. This is because fixed overheads maintained in
closing inventories are carried forward to the next accounting cycle (lowering the cost of sales) rather than
being written off in the current period (as a period cost, as in marginal costing).
When inventory levels fall, marginal costing yields a bigger profit. This is due to the release of fixed overhead
pushed forward in opening inventory, which raises the cost of sales and reduces earnings. Both techniques
yield the same profit if inventory levels remain unchanged.
 INVENTORY VALUATION WITH MARGINAL AND ABSORPTION COSTING

Absorption costing covers both direct and indirect costs, whereas marginal costing is based on variable
expenses but excludes fixed expenses. In general, if a cost is variable, it is also direct; hence, adding fixed
overheads to the marginal cost yields the whole absorption cost.
Whenever there is a closing inventory, the profits estimated by the two approaches will differ. The variation
in profit will be explained by differences in closing inventory value. Marginal costing is not permitted in
financial reporting, although absorption costing is permitted in both management accounting and financial
accounting.
When inventory levels rise or fall over time, earnings vary according to absorption and marginal costs. When
inventory levels rise, absorption costs yield a bigger profit. This is because fixed overheads maintained in
closing inventories are carried forward to the next accounting cycle (lowering the cost of sales) rather than
being written off in the current period (as a period cost, as in marginal costing).
When inventory levels fall, marginal costing yields a bigger profit. This is due to the release of fixed overhead
pushed forward in opening inventory, which raises the cost of sales and reduces earnings. Both techniques
yield the same profit if inventory levels remain unchanged.
 Terminal Questions
Short Answer Questions
Q1. What is Managerial Costing?
Q2. What is Absorption Costing?
Q3. What is Variable Costing?
Q4. Define Absorption?
Q5. What is Inventory valuation?
Q6. Define the term profit margin?
Q7. Define idle capacity.
Long Answer Questions
Q1. What are Marginal Costing Characteristics?
Q2. What are the Features of Variable Costing?
Q3. State 5 difference between marginal and absorption costing.
Q4. Why do we employ marginal and absorption costing?
Q5. What are the various Inventory Valuation Methods?
Human resources slide 9

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