Chapter

8
ABSORPTION AND
MARGINAL COSTING
Learning 0bjectives
After studying this chapter, you should be able to understand
Meaning and characteristics of absorption costing.
Ascertainment of income under absorption costing.
Advantages and limitations of absorption costing.
Meaning, definition and characteristics of marginal costing.
Assumptions of marginal costing.
Marginal costing vs. directldifferentiallvariable costing.
Marginal costing vs. absorption costing.
Determination of income under marginal costing.
Advantages of income determination under absorption and marginal costing.
Reconciliation of profit under absorption and marginal costing.

INTRODUCTION
An analytical study of the behaviour of overheads in relation to
changes in volume of output
reveals that there are some items of cost which tend to
vary directly with the volume of output
whereas, there are others which remain unaffected by variations in the volume of output. The former
class of costs represent the variable overheads and the latter fixed overheads.
Besides, there are
certain items of costs which are partly fixed and partly variable and are known as
semi-variable or
semi-fixed costs.
The volume of output fluctuates from one period of time to another due to seasonal
and other
factors. But fixed costs (including fixed portion of semi-variable costs)
being same during each
period, fluctuations occur in unit cost of products produced during different periods, thus
necessitating comparison of costs from one period of time to another. To
obviate this uneven
incidence of fixed costs on units of output, fixed costs are treated as
period costs and excluded from
product costs. Again, once certain facilities are installed, so long as there is no
capacities, certain costs (i.e., fixed costs) will have to be incurred whether or notchange
in the installed
the facilities are being
used at all or to whatever extent the facilities are used. From
this standpoint also, there is
of excluding fixed costs from justification
product costs. The essence of Marginal Costing technique lies in
 p t i o na n d M a r g i n
larginal Costing
8.2
Absorption and Marginal 8.3
considering fixed costs on the whole as separate, quite distinct from variable costs wi Costing Add:Value of
Opening
Stock

XXx
relevant to current operations. Variable costs only are matehed with revenues
undaonly Stock xxx
conditions of production and sales to compute what is known 'contribution' towarde.
as of Closing
: Value
fixed costs and yielding of profits. This is very useful from the point of view of recove of
decisionnery
Less
XXx
control. -making and Add:
U n d e r - a b s
Fixed Fat
sorbed Fixed
o r
Factory Overheads
b e d
XXx

XXX
ABSORPTION COSTING absorbed Fixed
Less:Over-absorbed Fixed Factory Overheads XXx

XXx
(A-B) XXx
Absorption costing also known as 'full costing is the total cost technique. It is the C.GrossProfit
and most widely used technique of ascertaining cost. CIMA, London, defines conventi. Administration, Selling and Distribution Overhe XXx

"the practice of charging all costs both variable and fixed to absorption costins Variable
operations, processes or producte XXX
Under this technique, product cost is made up of all direct costs (1.e. direct ." Fixed
material, direct laho (C-D) XXX
direct expenses and variable factory overheads) plus fixed Net Income or
Profit XXX
factory overheads absorbed atur, XXx
predetermined rate on the basis of normal capacity. The administration, selling and a

overheads are treated as period costs, and hence, are written off
against the
distribui
ibution
income for the period
eTRATION 1. From the
following intormation, prepare income
in
statement under
which they are incurred. absorption costing.

Normal capacity
1,00,000 units
DISTINGUISHING FEATURES OR CHARACTERISTICSs OF ABSORPTION Units produced
COSTING Opening stock
1,10,000 units
The basic features of absorption costing are as follows: 5,000 units
Units sold
1. All variable manufacturing costs and fixed factory overheads 1,05,000 units
are treated
and hence
as
product costs Selling price per unit T 30
charged to products, processes or operations. Direct material cost per unit
2. All R6
administration, selling and distribution overheads are treated as period costs, and hence Direct labour cost per unit
are written off 5
against the profits of the period in which they are incurred. Variable factory overheads per unit
3. As fixed
factory overheads are included in unit cost, the value of closing inventory includes Fixed manufacturing overheads
2,00,000
fixed factory/production overheads.
Variable administration, selling and distribution overheads T2 per unit sold
4. Under
absorption costing, cost per unit remains same only if there is no change in the level Fixed administration, selling and distribution overheads 71.00,.000
of output. However, in case the level of output changes, the cost
per unit also changes
because of the presence of fixed costs. SOLUTION:
ASCERTAINMENT OF INCOME UNDER ABSORPTION coSTING Income Statement Under Absorption Costing
The income under
absorption costing is determined as below: Particulars
A. Sales (1,05,000 x 30) 31,50,000
Income Statement Under Absorption Costing 8.Cost of Goods Sold:
Particulars Direct material cost (1,10,000 x 6) 60,000
A. Sales xXX Direct labour cost (1,10,000 x5) 5,50,000
B. Cost of Goods Sold:
variable factory overheads (1,10,000 x4) 440,000
Direct Material
XXX xed manufacturing overheads (1,10,000 x 2) 2,20,000
Direct Labour
Direct Expenses
xXx Fred manufacturing overheads absorption rate =2,00,000+1,00,000=2) 18,70,000

Variable Production/Factory Overheads

xxx

XXx
Ad:Opening Stock 5,000x 17) 85,000
19,55,000
Fixed Production Overheads (Actual Production x Predetermined 170,00
Rate) XXX

xXx
S:Closing stock (10,000 x 17) 1785,00
8.4 ADSorpuon

20,000 ords of Blocker and Weltmore, "Marginal Cost is the increase decrease in total cost which
Less: Over-absorbed fixed manufacturing overheads (2,20,000- 2,00,000) 17,138565000,000 or

e from producing or selling additional or fewer units of a product or from a change in the
e

C.Gross Profit (A-B) or exclusion

hod of production or distribution such the use of improved machinery, addition
as
distribution overheads:
D.Administration, selling and
2,10,000 selection of an additional sales channel."
Variable (1,05,000 x 2) ca DrOduct or territory, or
ofa
1,00,000
Fixed 3,10,000 Analysing the definitions given above, we find that with the increase in one unit of output, the
E. Net Income or Profit (C-D) 10,75,000 cOst is increased and this increase in total cost from the existing to the new level is known as
Marginal Cost.

ADVANTAGES OF ABSsORPTION COSTING For example, the cost of production of 1,000 units of radios is R 2,00,000 and that of 1001 units is
cost is 150, ie., 2,00,150-7 2,00,000.
The following are the important advantages ofabsorption costing: 200,150 the marginal
1. Absorption costing is a simple and most commonly used technique of ascertaining cost Marginal cost may also be defined as "the aggregate of variable costs" or "prime cost plus
2. The technique of absorption costing ensures that all costs including fixed and variah
ariable able overheads". Thus, if for the production of 1,000 units of a product the manufacturer has to
related to production are charged to products, processes or operations. er75,000 for materials, 50,000 for direct wages,
25,000 for variable overheads and 50,000
3. It ensures correct fixation of selling prices in the long run as fixed costs are also considere
dered fved overheads, the marginal cost can be ascertained as follows:
for calculating per unit cost. Per unit
Total
4. The ascertainment of shows gross
income under absorption cOsting
various decisions.
profit and net profit (1,000 units)
separately which helps in taking
5. It discloses inefficient and efficient utilization of resources allocated to a particular 75
Ost Direct materials 75,000
centre by indicating under absorption and overabsorption of fixed production
overheads Direct Wages 50,000 50
6. It conforms to the principle of accrual and matching of costs with revenues of the
relevant PrimeCost 1,25,000 125
period. Variable Overheads 25,000 25
Marginal Cost 1,50,000 150
LIMITATIONS OF ABSORPTION COSTING
Absorption costing suffers from certain limitations, the most important are as follows
1. As the cost per unit the
changes with in the level of output under absorption
change MARGINAL COSTING
costing, comparison and control of costs becomes difficult. The Institute of Cost and Management Acountants, London, has defined Marginal Costing as
2. In costing, some of the current period's fixed costs are carried forward to the "the ascertainment of marginal costs and of the effect on profit of changes in volume or type of
absorption the valuation of closing stock based on cost per unit inclusive of
next period because of output by differentiating between fixed costs and variable costs". "In this technique of costing only
fixed factory overheads. variable costs are charged to operations, processes or products, leaving all indirect costs to be written
3. It of against profits in the period in which they arise."
is not helpful in taking certain managerial decisions such as selection of profitable a

product/sales mix; make or buy decisions, accept or reject decisions, additional orders or
Thus, in this context, marginal costing is not a system of costing such as process costing, job
of
orders export; problem of key or limiting factor, determination of the optimum level of costing, operating costing, etc. but a technique which is concerned with the changes in costs and
activity, dose or shut down decisions, etc.
protits resulting from changes in the volume of output. Marginal costing is also known as 'variable
4. fixed
The manufacturing overheads may be absorbed
under or over recovery of overheads.
on wrong or arbitrary basis causing
costing.
5. It may not be possible to prepare flexible budgets under absorption costing BASIC CHARACTERISTIcs OF MARGINAL COSTING
MEANING AND DEFINITIONS OF MARGINAL coST AND MARGINAL COSTING
According to the Terminology of Cost Accountancy of the Institute of Cost and Management
The technique of marginal costing is based on the distinction between product costs and period
COsTS. Only the variable costs are regarded as the costs of the products while the fixed costs are
Accountants, Marginal Cost represents "the amount at any given volume of output by
London,
a8gregate costs are changed if the volume of output is increased by one unit". In practice, ths is
whicn Cdred as
period costs which will be incurred during the period regardless of the volume of output.
he main characteristics of marginal costing are as follows:
measured by the total variable costs attributable to orne unit. In this context, a unit may be a ingle 1 It is a technique of analysis and presentation of costs which help management in taking
article, batch of articles,
a an order, stage of production capacity, a man-hour, a pro
a
decisions and is not an independent system of costing such
n as process
department. It relates to the
change in output in the particular circumstances under nany managerial
consiaeta costing or ijob costing.
 LOsting AbSolpiio

whether variable or fixed are treated as product costs even though fixed cost are period
2. All elements of cost-production, administration and selling and
distribution classifios are
into variable and fixed components. Even semi-variable costs are analysed into fixed ed cOsts and have no relevance to current operations
and
variable. In marginal costing only variable costs are treated as product costs, fixed cost is
technique
treated as period cost and is charged to profit and loss account for that period.
3. The variable costs (marginal costs) are regarded as the costs of the products.
costing ditters from marginal costing from the point of view of inventory
4. Fixed costs are treated as period costs and are charged to profit and loss account for t
2 Absorptionalso. In
period for which they are incurred. valuation absorption costing, the stock of finished goods and work-in-process is
valued at total cost which includes both variable and fixed cost. In marginal costing, such
5. The stocks of finished goods and work-in-process are valued at marginal costs only. stocks are valued at marginal cost, ie., variable cost only. Hence, it results in higher
6. Prices are determined on the basis of marginal cost by adding 'contribution' which is the valuation of inventories in absorption costing as compared to marginal costing.
excess of sales or selling price over marginal cost of sales.
3. In absorption costing arbitrary apportionment of fixed costs, over the products, results in
under or over-absorption of such costs. While marginal costing excludes fixed costs and the
ASSUMPTIONS OF MARGINAL COSTING
question of under or over absorption of fixed costs does not arise.
The technique of marginal costing is based upon the following assunmptions: 4. In absorption costing, managerial decision-making is based upon 'profit which is the
1. All elements of
cost-production, administration and selling and distribution-can be excess of sales value over total cost. While in marginal costing, the managerial decisions are
segregated into fixed
and variable componernts. guided by 'contribution' which is the excess of sales value over variable cost.
2. Variable cost remains constant per unit of
output irrespective of the level of output and
thus fluctuates directly in
proportion to changes in the volume of output. DETERMINATION OF INCOME UNDER MARGINAL COSTING
3. The
selling price per unit remains unchanged or constant at all levels of activity. Under marginal costing only variable costs are charged to operations, processes or products. All
4. Fixed costs remain
unchanged or constant for the entire volume of production. fxed costs are written off against profits in the period in which they arise. The income under
5. The volume of
production or output is the only factor which influences the costs. marginal costing is determined as below:
Income Statement Under Marginal Costing
MARGINAL COSTING VS. DIRECT/DIFFERENTIALNARIABLE COSTING Particulars
The term
marginal costing is also referred to as 'variable A, Sales
costing or incremental costing. However, these terms are not costing', the
'direct costing', 'differential XXx
example, the use of the term direct costing is not exactly same in all
respects. For B.Variable Cost of Sales:
is onvariable and fixed costs and not appropriate since the emphasis of marginal costing Direct Material Cost XXX
on direct and indirect costs as is the case in direct Direct Labour Cost
always variable costs as some of them are fixed in nature.costing
Further more, all direct costs are not
the use of the term direct Hence Direct Expernses
costing in place of marginal
exactly the same as differential or incrementalcosting in
is inaccurate. Variable Production/Manufacturing Overheads
is not Similarly marginal costing
costing spite of the fact that both are the
techniques of cost analysis and cost presentation, and both
Variable Cost of Goods Product
the techniques
are used Add: Opening Stock
for decision
making and policy formulation. Differential costs are the increase or by management
cost that result from decrease in total
producing additional or fewer units or from the Less: Closing Stock
course of action. Thus, differential adoption of an alternative
in the costing takes into account changes in fixed cost also due to
output while fixed costs are excluded from change
cost are the same when fixed
costs do not
marginal costs. In fact, differential cost and marginat Add: Variable Administration Overheads
variable costing seems to be more change with change in output. Thus, the use of the
appropriate
and tem
acceptable. Add: Variable Selling and Distribution Overheads x

MARGINAL COSTING VS. ABSORPTION COSTING Variable Cost of Sales XXX

OR FULL COSTING C.Contribution (A- B)
The basic differences between
1.
Absorption costing and Marginal costing follows are as :
D.Fixed Overheads: Xx
Absorption costing is the total cost Fixed Factory/Production Overheads
technique. According to the Terminology of
Accountancy, absorption costing is "the Fixed Administration Overheads
fixed, to operations, practice of charging all costs, both variabie aand XXX|
processes, or products." Thus, under sts Fxed Selling and Distribution Overheads XXX| XXX
absorption
a" costing . Profit or Income Under Marginal Costing
 andM
Marginal Costing
a r g i n a lt
8.8 a n d

8.9
Absorption and Marginal
Asorption

OF MARGINAL CcoSTING
ILLUSTRATION 2. Following information relates to ABC Ltd. Costing nVANTAGES

Normal capacity following

are important advantages of marginal costing:
the inmpor
the

Units produced The

50,000 units
Opening stock
60,000 units
Advantages of Marginal Costing
Closing stock
2,000 units to operate and easy to understand
Selling price per unit 7,000 units
Simple
Removes complexitie of under-absorption of overheads
Variable cost per unit
Direct material
20 Helps management roduction Planning.
Direct labour No possibility of fictitiousprofits by over-valuing stocks
5
Facilitates calculation important factors like B.E
of
Variable factory overheads per unit R4 Valuable aid to management for Decision-Makina
Variable administration, selling and distribution 3
overheads per unit sold
Fixed Overheads: 2 Facilitates study of relative profitability
Manufacturing Complimentary to Standar Costing and Budgetary control
Administration 40,000 Helps in CostControl
9.
Selling and distribution 30,000 Profit Planning
You 60,000 10.
Management Reporting
are
required to prepare income statement under marginal costing.
sOLUTION: The technique of marginal costing is very stmple to operate and easy to understand. Since, fixed
costs are kept outside
the unit cost, the cost statements
prepared on the basis of marginal
Income Statement Under Marginal cost are much less complicated.
d Costing
osting
Particulars 2. It does away with the need for allocation, apportionment and absorption of fixved overheads
A. Sales (60,000+2,000-7,000 55,000 units @7 20 each) and hence removes the complexities of under-absorption of overheads.
B. Variable
11,00,000 3. Marginal cost remains the same per unit of output irrespective of the leve! of activity. It is
Cost of Sales
constant in nature and helps the management in production plamning.
Direct material cost (60,000 x 5) 3,00,000 4. It prevents the carry forward of current year's fixed overheads through valuation of closing
Direct labour cost (60,000x 4)
2,40,000 stocks. Since fixed costs are not considered in valuation of closing stocks, there is no
Variable factory overheads (60,000x3) 1,80,000 possibility of factitious profits by over-valuing stocks.
Variable Cost of Goods Produced 5. Itfacilitates the calculation of various important factors, ri. break-even point, espectationso
7,20,000
Add:Opening Stock (2,000 x 12) profits at different levels of production, sales necessary to earm a predetermined target oin
24,000 on profit due to changes of raw materials prices,
inureased wages, change
7,44,000
Profit, eect
sales mixture, etc.
Less: Closing stock (7,000 x 12) ot selling prices,
84,000 for decision-marking and fixation
Variable Cost of Goods Sold (55,000 x 12)
S a valuable aid to management make or buy decision, problem
of key or
6,60,000 mix,
Add: Variable
o n of a profitable product/sales level of activity, dose or
shut down
administration, selling and distribution overtheads (55,000x2) determination of the optimum
1,10,000 7,70,000 n g factor,
and capitalinvestment decisions, etc
Variable cost of sales (55,000 x14) 3,30,000 ns,evaluation of performance
diferent product lines, departments,
facilitiates the study of relative proftability of
C.Contribution (A-B) production facilities, sales divisions, etc
D. Fixed Overheads them
control and can be used alongwith
nplimentary to standard costing and budgetary
Manufacturing 40,000 t to
Administration
yield better results. variable or marginal cost tnat s
30,000 costs are not controllable
and it is only
and
non-controllable, iey
Selling and Distribution
60,000 1,30,000 COnt e a dividing costs
into controllable
marginal costing, by
Total Fixed Overheads st
tn cost control.
relationship
between cost,

E. Income or Profit Under Marginai costing making study of

a whole problem
2,00,000 t
helps the management
ment profit planning by
in profit
in
plannang and profit graphs
make the
Olume and break-even charts
Further,
undPOIs.
easily
S y understandable even to a layman
8.10
Absorption
and
Marginal and
larginal Costing
11. It is very usetul in management reporting8. marginal costing facilitatoe Costina Ahbsarption
811
exception' by focussing attention of the management towards more im
ates 'management COMPARIS N OF INCOME DETERMINATION UNDER
waste time on problems which do not require urgent attention of the hih.
tant areas MARGINAL COSTING ABSORPTION AND
igher managementhan to
ents. fixed costs are treated
orption costing, fixed
LIMITATIONS OR DISADVANTAGES OF MARGINAL COSTING Under as
product costs while
fixedcosts from product costs. The example
costs fror marginal costing
In spite of advantages, the udes given here illustrates the method of income
so many technique of
marginal costing suffers mination under absorption and marginal costing
limitations suffers from
from the
1. The technique of marginal costing is based upon following Example::When there is no opening or closing stock.
a number of assumptions
hold good under all circumstances. whicl. Income Statement or Statement of Cost and Profit
2. All costs are not divisible into
fixed and varable. There are
(Absorption Costing)
in nature. it is very difficult and certain costs which
are semisad. Product X Product Y
elements.
arbitrary to classify these costs into fixed and riable
Product Z Total
vard
variable
3. Variable costs do not always remain constant and do Sales(A) 15,000 30,000
volume of output because of the laws of
not always 10,000 55,000
vary in direct Les: Cost of Sales/ Production:
diminishing and proportion
Selling prices do not remain constant for ever and for all increasing returns.
On to t
4. Direct Material
3,500 10,000 2,500 16,000
discounts for bulk orders, levels of
changes in the general price level, etc. output due to compekition Direct Labour 5,000 8,000 1,500 14,500
Fixed costs do not remain constant after a Variable Overheads
5.
certain level of 1,500 2,000 1,000 4,500
ignores the fact that fixed costs are also controllable. activity. Further, marginal costing
Fied Overheads 1,500 2,500 1,000 5,000
6. The exlusion of Total Cost (B) 11,500
fixed costs from the stocks of 22,500 6,000 40,000
finished goods and Net Profit (A-B)
illogical since fixed costs are also incurred on the work-in-progress is
3,500 7500 4,000 15,000
marginal manufacture of products.
costing are underoalued and the Stocks valued o Income Statement or Statement of Cost and Profit
Similarly, as the stock are undervalued, theprofit
and loss account
cannot reveal true profits.
balance sheet does not (Marginal Costing)
7.
Although the technique of marginal give true a
picture. Product X Product Y Product Z Total
costing
absorption of fixed overheads, the problem overcomes the problem of under
over- or
still exists in | Sales (A)
Dariable overheads. regard to under or over-absorption of 15,000 30,000 10,000 55,000
8.
Less: Cost of Sales/Production:
Marginal costing completely ignores the 'time factor. Thus, Direct Material
Contribution but one takes if two jobs give equal 3,500 10,000 2,500 16,000
longer time to complete, the one which takes
Direct Labour 5,000 8,000 1,500 14,500
be
regarded as costlier than the other. But this
fact is
longer time should Variable Overheads 1,500 2,000 1,000 4,500
costing. ignored altogether under marginal Total (B)
10,000 20,000 5,000 35,000
9.The
technique of marginal costing cannot be applied in contract or
Contribution (A-B)
Less: Fixed Overheads 5,000 10,000 5,000 20,000
because in such cases, normally the value of ship-building industry Net Profit 5000
of fixed
overheads may result into losses work-in-progress is very high and the exus 15,000
every year and huge profit in and
In come statements shown earlier, the net profits arrived at, under absorption costing
completion of the job. tnE yca
10. Cost control can finich a Costing are the same, this is so because there is no opening or closing stock of
be better be achieved with the help of other
and
budgetary techniques, viz., stanaar g0ods or work-in-process. Valuation of stock in
e plus fixed cost) whereas in marginal costing, it isabsorption
control than by marginal costing 1S done at total cost
costing technique.
u s , the amount of profit and loss may be difterentdoneunder at marginal cost 1.e,
the two systemsvariaoiE
1. Fixation of
selling prices in the long run cannot be cOsts. it tnere are
Thus, pricing decisions
cannot be based on
done without considering opening or closing stocks
12. In the marginal
cost alone. his pont ot
difference can
present days of automation, the
cOsts
Example: When there are be well understood with the help or tou
1s
very high and hence
proportion of fixed costs in
relau
managerial decisions based upon only the marginal cost 8 Cost of opening
or closing stockS.
production (5,000 units)
important element of fixed cost
may not be correct.
8.12 and Marginal Costing
Absorption and Marginal Ahsorption
V'ariable oost 4 per unit) = { 20,000 Costinn 13
Fixed cost (Re. 0.20 per unit) = 7 1,000
TION 4. The following figures are extracted form the books of
LLUSTRAT
2017 and 2018 whose
capacity is 1000 lanps per annum: Sunny Electrical Ltd
Sales (4,000 units @R 6 per unit) = 24,000 or theyears
Closing stock 1000 units
Direct Material (Per Unit)
Absorption Costing Marginal Costing Direct Labour
Fixed Overhead
5
Selling Price
20
Sales 24,000 Sales B0
24,0 Production in 2017 was 10,000 units and in 2018 also it
21,1100 was 10000 units. Sale was 8,000 units in
Closing Stock|1,000 x 5, 000 4,200 units in 2018
Closing Stock (1,000 x 4) 2017 and 12,000
4
Prepare income statements assuming that the company uses:
28,200
L:Costof production 21,000 Less: Variable Cost 28,0K0 (a) Absorption Costing (b) Marginal Costing
Profit 7,200 Contribution 20,000 SOLUTION:
|Less Fixed cost 8,.000
Profit 1,000 (a) Income statement Under Absorption Costing
000 Particulars 2017
ILLUSTRATION 3. The selling price of a particular product is R 200 and the marginal 2018 2917 2018
130. During the month of April 800 units were
produced ot which 500 units were sold. Therecost is
Sales (A) 8,000x 80
opening stock at the commencement of the month. Fixed costs amounted to
no 12,000 8 6.40.000
36,000. 9,60,000
You are
required to prepare income statements
Cost ofSales:
using Direct Material 10,000 x 35 10000 35 35000
(a) absorption costing and Direct Labour
3,50,000
10,000x5 10.000x5 50000
b) marginal costing. Fixed Overheads
50,000
10.000x20 10000 20 200.000 2,00,.000
SOLUTION: 600.000 6,00,000
Add: Opening Stock 600.000x 1,20,000
(a) Income Statement Under Absorption Costing 2000/10.200
600.000 7,20,000
Particulars |Less: Closing Stock 6.00,000x 120.000
Sales (500 x 200)
1,00000 Cost of Sales (B) 2,000/10,000
Less: Cost of Sales/Production:
Profit or Income (A -B)
80.000 7,20,000
Marginal Cost (800 x 130) 10.000 2,40,000
1,04,000
Fixed Costs (b) Income Statement Under Marginal Cesting
36,000
Total Cost Particulars 2017 2O13 2017 2018
1,40,000
Less: Closing Stock (1,40,000 300/800)x
52,500 Sales (A)
Cost of Sales S.000xS0 120000 640,000 9,60,000
87500 Variable Cost:
Profit or Income Under
Absorption Costing 12.50 Direct Material
Direct Labour
10.000 x 35 3.50,000 3,50,000
(b) Income Statement Under Marginal
Particulars
Costing 10,00x5 l00005 S0,000 50,000
Sales (500 200) Add: Opening Stock 4,00,000 4,00,000
1,00.0
80,000
Less: Marginal Cost (800 x 130) 1,04,000
Less: Closing Stock 400,000 4,80,000
Less: Ciosing o5
Stock (300x 130) 39,000 Variable Cost ot Sales 2000x4 80,000
Contribution 350A0 (B) 3,20,000 4,80,000
Less: Fixed Costs
Contribution (A - B)
Less: Fixed Cost 3,20,000 4,80,000
( 2,00,000
Loss Under Marginal Costing Profit or Income 2,00,000
,20,000 2,80,000
 (in units)
815
8.14 (in units) 10.000
Absorption and Marginal Costing Output
9,000
Sales
unit (in ) 9,000
ILLUSTRATION 5. A company produces only one product which had the following costs:
Price
per
t h ey e a r
(in ) 14 10,000
Variable manufacturing costs T4 per unit
Selling
Cost
for
unit (in )
85,000 14
ied per
iableC o s t p er
2.90 85,0
Fixed manufacturing costs 1,00,000 per annum
The normal capacity is set at 1,00,000 units. There are
Y o ua
a sired
r e r e q u i r e d

to prepare
vO
a
Comparative profitabilitv statement under 2.90
overhead rate is Re. 1 per unit.
no
work-in-process inventories. Fixed for
the vears assuming that materials are issued on absorption costing and
al openinginventorv in 2016 may
naginal. costing
be taken at the First-in-First-out
In 2015, the company produced 1,00,000 units and sold 90,000 units at a price of T 8 per unit. In
The value of
closing inventory in 2015. (FIFO)
2016, the company produced 1,10,000 units and sold 1,15,000 units at the same price. hzsts.
Comparative Profitability Statement
SOLUTION
You are required to prepare income statements for 2015 and 2016 based on
absorption costind
and variable costing
ing
Absorption Costing Marginal Costing
2015 2016
sOLUTION: Particulars 2015 2016
Income Statement Under Absorption Costing 1,26,000
Sales at R
14 per
unit
1,40,000 1,26,000 140,000
Particulars 2015 2016 2015 2016 cost at R
2.90 per unit 29,000 26,100 29,000 26,100
Variable
( ( Add: Opening Inventory 11,400 2,900
29,000 37 500 29,000
() Sales at 8 per unit 90,000x8 1,15,000x8 7,20,000 9.20,000 29,000
Variable manufacturing cost at 4 per unit 1,00,000x4 1,10,004 4,00,000 Less: Closing Inventory 11,400 2,900
4,40,000 37500
17,600 26,100 29,000 |
Add: Opening Inventory at 5 per unit 10,000x5 50,000
Add: Fixed Cost 85,000 85,000
Add: Fixed cost at Re 1 per unit 1,00,000x1 1,10,000x1 1,00,000 1,10,000 Sales 1,02,600 1,22,500 26,100 29,000
5,00,000 Cost of 17500 99C0 1,11,00
6,00,000 i 23,400
Margin [)-i)]
Less: Closing Inventory at 5 per unit 10,000x5 5000x5 50,000 25,000 Less: Fixed cost
85,000 85,000
Standard cost of sales 4,50,000 5,75,000 23,400 17,500 14,900 26,00U
Net Profit
Less: Over Absorption of fixed overheads 10,000 Working Notes:
(i) Cost of Sales 4,50,000 5,65,000 2015
2016
Net Income [(i)-{ü)] 2,70,000 3,55,000 10,000x 14=140,00
Sales
9,000 x 14- 1,26,000 9.000 x 2.90- 26,100
Income Statement Under Variable Costing () Calculation of 10,000 x 2.90=7 29,000
Cost
2016 2015 2016 (i) Calculation of Variable
Particulars 2015
(i) Calculation of opening Inventory
( ( in 2015
There is no opening inventory
is 1000 units, it is valued at
(i) Sales at ? 8 per unit 90,000x8 1,15,000x8 7,20,000 9,20,000 Opening Inventory in 2016 unit, and under marginal costing
at total cost per
it is valued
Variable manufacturing cost at 4 per unit 1,00,000x4 | 1,10,000x4 4,00,000 4,40,000 S o r p t i o n costing as calculated
in 2015
Add: Opening Inventory at 4 per unit 10,000 x4 40,0U0 variable cost.
taken at the value of closing inventory
in 2016 has been
4,00,000 4,80,000 Openng inventory
below. Marginal Costing
Less: Closing Inventory at 4 per unit 10,000x4 5,000x4 40,000 20,000 p) Calculation of Closing Inventory (2015) Absorption Costing
3,60,000 4,60,000 1000 x2.90-R 2900
(ii) Variable cost of Sales
3,60,000 4,60,000 29,000+85,0001.00 1,400
Contribution (i)- (i) costing
1,00,000 1,00,000 10,000 an
actual
Less: Fixed cost vehicles. It uses
3,60,000 and sells
motor and April, 20
2,60,000 to March
ILLUSTRATION
assembles
Net Income Motors relating
ABC basis. Data
monthly
c a l c u l a t e d on a
system, in which unit cost
Costs a r e
relating to a factory for two years. April
Lt
ILLUSTRATION 6. The following are the cost data re:
March
2016
2015
150
10,000
10,000
Installed capacity (in units)
Opening Inventory (in units) Nil
1,000 Unit data
Nil
Closing Inventory (in units) 1000 Beginning Inventory
 i g Notes, 8.11
8.16 Absorption and Marginal Costing March
Production 500
400
ales
Caleulation o fS a le 24,000 x 350 =7 April
Sales 350
520 C a l c u l a t i o no fV a r i a b l e
84,00,000 24 000x 520=71,24,80,00
Variable cost data :
Manufacturing cost per unit produced 10,000 Manufacturing C o s t 10,000 x 500 =7
10,000 50,00,000
Distribution cost per unit sold 3,000 3,000 u l a t i o n

of Opening Inventory
.

10,000x 400=7 40,00,00

Fixed cost data: ontory in
inventory
March, opening
Manufacturing costs
Marketing osts
20,00,000 20,00,00 Thereis
no
p r o d u c e di n M a r

opening
in March minus
350 inventory in April is 150 units, ie.
units sold during March.
6,00,000 6,00,000 k inclusive Under 500 units
at total
« of fixed cOst. Ihe
opening absorption costing inventory
The Selling Price per motor vehicle is 24,000. s
valued
losing inventory in March inventory in April has been taken at
calculated as below.
Required:
Present Income Statements for ABC Motors in March and April 2017 under Calculation of Closing Inventory
(c) variable costing and (b) absorption costing. (o)
For
March:
000/500) x (150) =R21,00,000
(i) Explain the differences between: (@) and (}) for March and April. inventory 150+ 400-520
For April,
closing =30 units
sOLUTION The
of
value closing
of clos inventory (April) (60,00,000/400) x (30) =7450.0
=
( INCOME STATEMENT OF ABC MOTORS UNDER VARIABLE COSTING March
stribution Cost April
Particulars March
April Calculation
of Variable 3,000x350-7 10,50,00 3.000520- 15.50,00
to) net income under absorption costing and variable
Sales ( 24,000 x 350 24,000 x 520
Thedifference in costing is as below:
6,00,000
March:7 18,50,000-12,50,000 T
84,00,000 1,24,80,000 =
Variable Cost R 4,50,000 =
Manufacturing Cost@R 10,000
Distribution Cost @3,000
35,00,000 52,00,000 April:726,70,000-31,20,000
10,50,000 15,60,000 The above shown ditterences in income are mainly due to the difference in the method of
Total Variable Cost (i)
45,50,000 67,60,000 lation of closing inventory. Under absorption costing, inventory is valued at total cost including
Contribution [i)-(ii)] 38,50,000 57,20,000
Less: Fixed Cost hedcost whereas under variable costing fixed cost is excluded from the same.
Manufacturing Costs 20,00,000 20,00,000
Marketing Costs 6,00,000 6,00,000 26,00,000 26,00,000
RECONCILIATION OF PROFIT UNDER ABSORPTION AND MARCINALCOSTING
Net income
12,50,000 31,20,000 As discussed earlier, profit ascertained under absorption costing may not be the same as
INCOME STATEMENT OF ABCMOTORS UNDER ABSORPTIONCOSTING Rermined under marginal costing because of the difference in the valuation
of stocks umder the two
March April inctuding ixed production
kmques. Valuation of stock in absorption costing is done at total cost
( (
eheads whereas in marginal costing it is done at variable cost
Sales at 24,000 per unit 84,00,000 1,24,80,000 only
Less : Cost of Goods Sold WE Can reconcile the two profits by preparing a reconciliation statement as under
Variable Manufacturing Cost 50,00,000 40,00,000 Under Absorption and MarginalCosting
Fixed Manufacturing Cost 20,00,000 20,00,000
datement Showing Reconciliation of Profit
xXx
70,00,000 60,00,000
rott under absorption costing XXx
Add: Opening Inventory 21,00,000 dd: Fixed production overheads included in opening stock* XXX
70,00,000 81,00,000
4,50,000 76,50,000 XXX
Less: Closing Inventory 21,00,000 49,00,000 48,30,000
|55: Fixed production
10n overheads included in closing stock XXX|
Gross Income 35,00,000
Less: Marketing and Distribution Cost:
Dit under marginal costing
6,00,000 6,00,000
Fixed Marketing Cost
Variable Distribution Cost 10,50,000 16,50,000 15,60,000 21,60,000 LUSTRATION 8. Star Ltd. provides
Normal capacity
you thefollowing
intormation 40,000 units
50,000 units
Net Income 18,50,000 26,70,000
Units produced 5,000 units
Closing stock
 Absorption and Marginal Costi AbBorption
and
Marginal Costing
8.19
8.18 overheads (50,000x 3
Opening stock Variable production produced
1,50,000
cost of goods 6,00,000
Units sold Variable x 12)
Stock (3,000
unit Opening ,000
Selling price per M:
Variable cost per
unit 6,36,000
12)
Direct material
Closing
stock (5,000 x
60,000
Less:
Cost of Goods
Sold
Direct labour
unit
Variable 5,76,000
overheads per selling and distribution overheads 5,76,000
Variable production Variable administration,
Sales (48,000 x 12) 6,24,000
Fixed Overheads Cost of
Production overheads Variable
C.Contribution (A- B)
Administration overheads R40,M D.Fixed Overheads:
distribution overheads
Selling and Production o v e r h e a d s 40,000
You are required to
: Administration overheads 30,000
(a) Prepare irncome statement under i) absorption costing and (i) marginal costing distribution overheads 30000 1,00,000
ng Selling and
Under Marginal Costing (C-D) 24,000
(b) Prepare a statement reconciling the difference in profit, if any. E. Income or Profit
(b) Statement Showing Reconciliation of Profit
sOLUTION
(a) 5,26,000
costing
Profit under absorption 1) 3,000
Income Statement Under Absorption Costing production overheads included
in opening stock (3,000 x
Add: Fixed
5.29,000
Particulars
1) 5,000
A. Sales (48,000 25) Less: Fixed production overheads included in closing stock (5,000 x
12,00,000 5,24000
B. Cost of Goods Sold: Profit under marginal costing
Direct material cost (50,0005) 2,50,000
Direct labour cost (50,000 x4)
2,00,000 M Review Questions
Variable production overheads (50,000x3) 1,50,000
Fixed production overheads (50,000 x 1)
[Absorption Rate = 40,000 40,000]
50,000 A. SHORT ANSWER TYPE QUESTIONs
6,50,000
1. What do you mean by absorption costing?
Add: Opening Stock [3,000x (5+4+3+1)1 2. What is full costing ?
(Sales +Closing Stock-Units Produced)
39,000 3. Give any two basic features of absorption costing.
6,89,000 4. What is variable costing?
Less:
Closing stock (5,000 x 13) 65,000 What is meant by marginal costing ?
6,24,000 What are the advantages of absorption costing ?
Less:Over absorbed fixed production overheads (50,000 40,000) 6,14,000
6.
10,000 How is income ascertained under absorption costing ?
5,86,00 8. Give any three limitations of absorption costing
C.Gross Profit (A-B)
D.Administration, Selling and Distribution Overheads (30,000+30,000) 60,00
8 Define marginal cost and marginal costing.
E. Net Inocome or Profit 5,26,000
0. Distinguish between absorption costing and marginal costing
Distinguish between marginal cost and direct cost.
Give a proforma for ascertainment of income under marginai costng
28.
(i) Income Statement Under Marginal Costing9 Why the profit under marginal costing differs trom profit under absorpton costing?
Particulars
A. Sales (48000
B. Variable Cost
25) 12,00,000 ESSAY TYPE QUESTIONS
of Sales: What is absorption costing ? Explain the characteristics of absorpton costing
Direct material (50,000x5) 2,50,000
Nplain ascertainment of profit under () absorption costing, and (i) marginal costing.
Direct labour
(50,000 4) 2,00,000 |
w h a t do you understand by marginal costing ? What are its advantages and limitations ?