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Absorption and

Marginal
Costing

Definition
Absorption costing
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.

Presentation of
costs on income
statement

Trading and profit ans loss account


Absorption costing

Marginal costing

Sales
X Sales
X
Less: Cost of goods sold
X Less: Variable cost of
Goods sold
X
Gross profit
X Product contribution margin X
Less: Expenses
Selling expenses X
Admin. expenses X
Other expenses X

Less: variable non- manufacturing


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

Variable and fixed manufacturing

Net Profit

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

Difference between
absorption and marginal
costing

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
includes the variable
cost only

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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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 covered with the change in
sales volume

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Cost Volume Profit


Analysis

Types of Costs

Variable
Fixed
Semi Variable

Total Variable Cost


Total Long Distance
Telephone Bill

Total variable costs change


when activity changes.
Telephone bill is based
on how many minutes
you talk.

Minutes Talked

Variable Cost Per Unit


The cost per long
distance
minute talked is
constant.
For example, 10
cents per minute.

Per Minute
Telephone Charge

Variable costs per unit do not change


as activity increases.

Minutes Talked

24
18
12
6
0 1 2 3 4 5
Volume
(Thousands of passengers)

Total Variable Costs


(thousands)

Variable Costs Example

Total Fixed Cost

Monthly Basic
Telephone Bill

Total fixed costs remain unchanged


when activity changes.

Number of Local Calls

Your monthly
basic
telephone bill
probably
does not change
when
you make more
local calls.

Semi variable Costs


Contain fixed portion that is incurred
even when facility is unused & variable
portion that increases with usage.
Example: monthly electric utility charge
Fixed service fee
Variable charge per kilowatt hour used

Total Utility Cost

Cont..

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Variable
Utility Charge
Fixed Monthly
Utility Charge

Activity

Assumptions of CVP
Analysis
Expenses can be classified as either
variable or fixed.
CVP relationships are linear over a wide
range of production and sales.
Sales prices, unit variable cost, and total
fixed expenses will not vary within the
relevant range.

Assumptions of CVP
Analysis
Volume is the only cost driver.
Inventory levels will be unchanged.
The sales mix remains unchanged
during the period.

Contribution Margin
Income Statement
Sales
- Variable Costs
Contribution Margin
- Fixed Costs
Operating Income