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Marginal costing
The difference in reported profits is calculated as the difference between the fixed production
overhead included in the opening and closing inventory valuations using absorption costing.
Increase in a period
ABSORPTION Closing inventories are valued at Absorption costing reports higher profit
COSTING full production cost Fixed overheads included in closing inventory
Cost of sales decreased
RECONCILIATION Hence, profit higher
$ Decrease in a period
Marginal costing profit X Absorption costing reports lower profit
Adjust for fixed overheads in inventory: Fixed overheads included in opening inventory
+ increase / – decrease X/(X)
_____ Cost of sales increased
Absorption costing profit X
_____
_____ Hence, profit lower
Fixed production costs are incurred in order to make output and so it is only
'fair' to charge all output with a share of these costs
Closing inventory will be valued in accordance with IAS 2
Appraising products in terms of contribution gives no indication of whether
fixed costs are being covered
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Notes