Absorption and Marginal

Costing

Prepared by Mr Rabeel Sabar

 Direct and Indirect Costs

• Direct costs are those costs that

can be specifically traced to the
cost object.

• Indirect costs are costs that cannot

be specifically traced to the cost
object.
 Product Costs
Direct Direct Indirect Indirect
Other
Materials Labor Labor Materials

Manufacturing Overhead

All costs incurred in getting product to saleable

condition
 Period costs
All costs incurred for a period of
time regardless of production
Sometimes classified into:
• Marketing expenses
• General (administrative)
expenses
• Financial expenses
 Fixed and Variable Costs
• Fixed costs
– Those costs that in total will remain the
same for a period of time and over a
relevant range or output.
• Rent or Insurance
• Variable costs
– Those costs that in total will tend to
increase as output level increase.
• Direct Materials or Labour
Cost of Goods Sold

• Finished Goods Inventory

• Beginning inventory
+ Cost of goods manufactured
= Cost of goods available for sale
– Ending inventory
= Cost of goods sold
 Absorption Costing
• It is costing system which treats all
manufacturing costs including both
the fixed and variable costs as
product costs.

• It is required for external finanical

reporting purposes.
 Marginal Costing
• It is a costing system which treats only
the variable manufacturing costs as
product costs. The fixed manufacturing
overheads are regarded as period costs.

• It helps in internal decision making

process.
Overview of Absorption and
Marginal Costing

The only cost of driving my car

on a 200 mile trip today is
$12 for gasoline.

Variable
Costing
Overview of Absorption and
Marginal Costing
No! You must consider these costs too!
Cost Per month Per day
Car payment $ 300.00 $ 10.00
Insurance 60.00 2.00

Absorption
Costing
Overview of Absorption and Marginal
Costing
You are wrong. I have the car
payment and the
insurance payment even if
I do not make the trip.

Variable
Costing
Overview of Absorption and Marginal
Costing
Who’s right?
How should we treat the car
payment and the insurance?
 Overview of Absorption and
Variable Costing
Absorption Variable
Costing Costing

Direct Materials
Product
Product
Direct Labor
Costs
Costs
Variable Manufacturing Overhead

Fixed Manufacturing Overhead

Period
Period
Variable Selling and Administrative Expenses
Costs
Costs
Fixed Selling and Administrative Expenses
Income Analysis Under Variable Costing
and Absorption Costing

Frand Manufacturing Company

has no beginning inventory and
sales are estimated to be 20,000
units at $75 per unit, regardless of
production levels.
 Income Analysis Under Variable Costing
and Absorption Costing
Proposal 1: 20,000 Units to Be Manufactured and Sold
Total Cost Unit Cost
Manufacturing costs:
Variable $ 700,000 $35
Fixed 400,000 20
Total costs $1,100,000 $55
Selling and administrative exp.
Variable ($5 per unit sold) $ 100,000
Fixed 100,000
Total expenses $ 200,000
 Income Analysis Under Variable Costing
and Absorption Costing
Proposal 2: 25,000 Units to Be Manufactured; 20,000 Units to Be Sold
Total Cost Unit Cost
Manufacturing costs:
Variable $ 875,000 $35
Fixed 400,000 16
Total costs $1,275,000 $51
Selling and administrative exp.
Variable ($5 per unit sold) $ 100,000
Fixed 100,000
Total expenses $ 200,000
 Frand Manufacturing Company
Absorption Costing Income Statements
20,000 Units 25,000 Units
Manufactured Manufactured
Sales $1,500,000 $1,500,000
Cost of goods sold:
Cost of goods manufactured
(20,000 units x $55) $1,100,000
 Frand Manufacturing Company
Absorption Costing Income Statements
20,000 Units 25,000 Units
Manufactured Manufactured
Sales $1,500,000 $1,500,000
Cost of goods sold:
Cost of goods manufactured
(20,000 units x $55) $1,100,000
(25,000 units x $51) $1,275,000
 Frand Manufacturing Company
Absorption Costing Income Statements
20,000 Units 25,000 Units
Manufactured Manufactured
Sales $1,500,000 $1,500,000
Cost of goods sold:
Cost of goods manufactured
(20,000 units x $55) $1,100,000
(25,000 units x $51) $1,275,000
Less ending inventory:
(5,000 units x $51) 255,000
Cost of goods sold $1,100,000 $1,020,000
Gross profit $ 400,000 $ 480,000
Selling and administrative expenses
($100,000 + $100,000) 200,000 200,000
Income from operations $ 200,000 $ 280,000
 Frand Manufacturing Company
Variable Costing Income Statements
20,000 Units 25,000 Units
Manufactured Manufactured
Sales $1,500,000 $1,500,000
Variable cost of goods sold:
Variable cost of goods manufactured:
(20,000 units x $35) $ 700,000
(25,000 units x $35) $ 875,000
 Frand Manufacturing Company
Variable Costing Income Statements
20,000 Units 25,000 Units
Manufactured Manufactured
Sales $1,500,000 $1,500,000
Variable cost of goods sold:
Variable cost of goods manufactured:
(20,000 units x $35) $ 700,000
(25,000 units x $35) $ 875,000
Less ending inventory:
(0 units x $35) 0
(5,000 units x $35) 175,000
Variable cost of goods sold $ 700,000 $ 700,000
Manufacturing margin $ 800,000 $ 800,000

Continued
 Frand Manufacturing Company
Variable Costing Income Statements
20,000 Units 25,000 Units
Manufactured Manufactured

Manufacturing margin $ 800,000 $ 800,000

Variable selling and administrative
expenses 100,000 100,000
Contribution margin $ 700,000 $ 700,000
Fixed costs:
Fixed manufacturing costs $ 400,000 $ 400,000
Fixed selling and administrative
expenses 100,000 100,000
Total fixed costs $ 500,000 $ 500,000
Income from operations $ 200,000 $ 200,000
 IF Units Sold < Units produced

THEN Variable Costing < Absorption Costing

Income Income
 IF Units Sold > Units produced

THEN Variable Costing > Absorption Costing

Income Income
 Absorption costing Marginal costing

Fixed Fixed manufacturing

manufacturing overhead are treated
Treatment for overheads are as period costs. It is
Fixed treated as product believed that only the
Manufacturing costing. It is variable costs are
Overheads believed that relevant to decision-
products cannot be making.
produced without Fixed manufacturing
the resources overheads will be
provided by fixed incurred regardless
manufacturing there is production or
overheads not
 Absorption costing Marginal costing

Value of High value of Lower value of

Closing Stock closing stock will be closing stock that
obtained as some included the variable
factory overheads cost only
are included as
product costs and
carried forward as
closing stock