Absorption and marginal costing

Absorption costing vs. Marginal

costing

Absorption costing :It is costing system

which treats all manufacturing costs
including both the fixed and variable costs
as product costs.
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 cost.

Absorption Costing
Cost
Manufacturing cost
Direct
Materials

Direct
Labour

Non-manufacturing cost

Overheads

Finished goods

Period cost

Cost of goods sold

Profit and loss account

Marginal Costing
Cost
Manufacturing cost
Direct
Materials

Direct
Labour

Finished goods

Non-manufacturing cost

Variable
Overheads

Fixed
overhead

Cost of goods sold

Period cost

Profit and loss account

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Presentation of costs on income

statement

Trading and profit ans loss account

Absorption costing
Sales
Less: Cost of goods sold

Gross profit
Less: Expenses
Selling expenses X
Admin. expenses X
Other expenses X

Marginal costing
$
X
X

Variable and fixed manufacturing

Net Profit

Sales
Less: Variable cost of
Goods sold
Product contribution margin

$
X
X
X

Less: variable non- manufacturing

expenses
Variable selling expenses
Variable admin. expenses
Other variable expenses
Total contribution expenses

X
X
X
X

Less: Expenses
Fixed selling expenses
Fixed admin. expenses
Other fixed expenses
Net Profit

X
X
X
X

A company started its business in 2005. The following information

Was available for January to March 2005 for the company that produced
A single product:
$
Selling price pre unit
100
Direct materials per unit
20
Direct Labour per unit
10
Fixed factory overhead per month
30000
Variable factory overhead per unit
5
Fixed selling overheads
1000
Variable selling overheads per unit
4
Budgeted activity was expected to be 1000 units each month
Production and sales for each month were as follows:
Jan
Feb
March
Unit sold
1000
800
1100
Unit produced
1000
1300
900
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January
$
Sales
100000
Less: cost of good sold ($65) 65000
Adjustment for Over-/(under)
Absorption of factory overhead
Gross profit
35000
Less: Expenses
Fixed selling overheads 1000
Variable selling overheads 4000
Net profit
30000

February
$
80000
52000
28000

March
$
110000
71500
38500

9000
37000

(3000)
35500

1000
3200
32800

1000
4400
30100

Marginal costing

January
$
100000

Sales
Less: Variable cost of good
sold ($35)
35000
Product contribution margin 65000
Less: Variable selling overhead4000
Total contribution margin
61000
Less: Fixed Expenses
Fixed factory overhead 30000
Fixed selling overheads 1000
Net profit
30000

February
$
80000

March
$
110000

28000
52000
3200
48800

38550
71500
4400
67100

30000
1000
17800

30000
1000
36100

Wk1:
Standard fixed overhead rate
= Budgeted total fixed factory overheads
Budgeted number of units produced
=

$30000
1000 units
= $30 units
Wk 2:
Production cost per unit under absorption costing:
Direct materials
Direct labour
Fixed factory overhead absorbed
Variable factory overheads
Back

$
20
10
30
5
65
10

Wk 3:
(Under-)/Over-absorption of fixed factory overheads:
January
February
March
$
$
$
Fixed overhead
30000
39000
27000
Fixed overheads incurred 30000
30000
30000
0
9000
(3000)
1000*$30
1300*$30
900*$30

No fixed factory overhead

Wk 4:
Variable production cost per unit under marginal costing:
$
Direct materials
20
Direct labour
10
Variable factory overhead
5
Back
35

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Difference between absorption

and marginal costing

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Absorption costing
Treatment for Fixed
fixed
manufacturing
manufacturing overheads are
overheads
treated as product
costing. It is
believed that
products cannot be
produced without
the resources
provided by fixed
manufacturing
overheads

Marginal costing
Fixed manufacturing
overhead are treated
as period costs. It is
believed that only the
variable costs are
relevant to decisionmaking.
Fixed
manufacturing
overheads will be
incurred regardless
there is production
or not
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Value of
closing stock

Absorption costing
High value of
closing stock will be
obtained as some
factory overheads
are included as
product costs and
carried forward as
closing stock

Marginal costing
Lower value of
closing stock that
included the variable
cost only

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Absorption costing
Marginal costing
Reported If the production = Sales, AC profit = MC Profit
profit
If Production > Sales, AC profit > MC profit
As some factory overhead will be deferred as
product costs under the absorption costing
If Production < Sales, AC profit < MC profit
As the previously deferred factory overhead
will be released and charged as cost of goods
sold
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Argument for absorption costing

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Compliance with the generally accepted

accounting principles
Importance of fixed overheads for production
Avoidance of fictitious profit or loss

During the period of high sales, the production is

small than the sales, a smaller number of fixed
manufacturing overheads are charged and a higher
net profit will be obtained under marginal costing
Absorption costing is better in avoiding the
fluctuation of profit being reported in marginal
costing
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Arguments for marginal costing

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More relevance to decision-making

Avoidance of profit manipulation

Marginal costing can avoid profit manipulation by

adjusting the stock level

Consideration given to fixed cost

In fact, marginal costing does not ignore fixed costs

in setting the selling price. On the contrary, it
provides useful information for break-even analysis
that indicates whether fixed costs can be converted
with the change in sales volume
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Thanks

Any questions..

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