10/1/2023

Absorption Costing & Marginal Costing

Minoli Jayasekera MBA (PIM-SJP), B.Sc. (Acct.) Hons., ACA, ACMA (UK), CGMA (UK), ACMA (SL)
077 984 8414 minoli.jayasekera@gmail.com
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Cost
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What is Cost?

Cost is the expenditure incurred on resources to

manufacture or acquire assets.

Costing is the technique of ascertaining such

costs.

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Objectives of computing Costs

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Objectives of computing Costs

For Pricing
To value inventory
To make decisions
To measure performance
For Controlling
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Classifications of Cost

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Direct and Indirect Classification of Costs

Classification based on identification and traceability of
costs with a cost object

Direct Cost - Cost specifically and exclusively identified with

a cost object

Indirect Cost - Cost that cannot be specifically and

exclusively identified with a cost object
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Direct and Indirect Classification of Costs

Cost

Direct Cost (Prime Cost) Indirect Cost (Overheads)

Direct Indirect
Material Cost Material Cost
Direct Indirect
Labour Cost Labour Cost
Direct Indirect
Other Cost Confidential
Other Cost

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Product and Periodic Classification of Costs

Product Cost - Cost identified with goods produced or
purchased for resale
Examples - Manufacturing Cost, Cost of goods purchased

Periodic Cost - Considered as expenses in the period in

which they are incurred
Examples - Administration expenses, Selling and
distribution cost, finance cost and other expenses
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Product and Periodic Classification of Costs

Manufacturing Unsold Recorded as

Product Cost
Costs an asset
(Inventory)

Sold

Non-manufacturing Recorded as
Periodic Cost
Costs an expense in
current FY
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Classification of Costs based on Cost Behaviour

Variable Cost - varies in direct proportion to volume of

activity

Fixed Cost - remains constant over a wide range of activity

for a specific time period

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Total
Variable Cost (Rs.) Unit
Variable Cost (Rs.)
16,000 16,000

8,000 Variable 8,000

Cost
800 800
80
0 1 10 100 200 0 10 100
Activity Level Activity Level
(Units) (Units)
Total Unit
Fixed Cost (Rs.) Fixed Cost (Rs.)

Fixed
20,000
Cost 20,000

0 100 Activity Level (Units)

0 100 Activity Level (Units)
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Costing Systems

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Absorption Costing

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Absorption Costing
Full Costing Method

All production costs (both fixed and variable)

absorbed into products

Non-manufacturing Overhead Costs considered as a

periodic cost and deducted from Profit
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Cost

Manufacturing Non-manufacturing
(Administration, Distribution,
Prime Cost (Dir. Mat., Manufacturing Finance & Other)
Dir. Lab., Dir. Other) Overhead
Statement of
Inventories Profit or Loss

Work-in- Finished Cost of Goods

progress Goods Sold
Statement of
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Financial Position
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Statement of Profit or Loss

based on Absorption Costing
Sales XXX
(-) Cost of Sales (XXX)
Gross Profit XX
Administration Expenses (XX)
Distribution Costs (XX)
Finance Costs (X)
Other Expenses (X)
Net Profit Confidential
X 17

Marginal Costing

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Marginal Costing
Variable Cost Method

All Variable Costs charged to products

Contribution is computed by deducting Manufacturing and

Non-manufacturing Variable Costs from Sales

All Manufacturing and Non-manufacturing Fixed Costs are

considered as a Periodic Cost and deducted from Profit 19
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Cost

Manufacturing Non-manufacturing

Prime Cost Manufacturing O/H

Variable Fixed Periodic Cost

Statement of
Inventories Profit or Loss

Work-in-progress Finished Goods Cost of Goods Sold

Statment of Financial Position

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Statement of Profit or Loss

based on Marginal Costing
Sales XXX
(-) Variable Manufacturing Costs (XXX)
(-) Variable Non-manufacturing Costs (X)
Contribution XX
Fixed Manufacturing Costs (X)
Fixed Non-manufacturing Costs (X)
Net Profit X
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Effects of
Opening & Closing Inventories

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If there are
No Opening or Closing Inventories

Profit as per Absorp. Cost. = Profit as per Marg. Cost

Sales Volume = Production Volume

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Effects of
Opening & Closing Inventories on Profit
Profit as per Absorp. Cost. > Profit as per Marg. Cost

Closing Inventories > Opening Inventories

Profit as per Absorp. Cost. < Profit as per Marg. Cost

Closing Inventories < Opening Inventories

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Absorption Costing vs.

Marginal Costing

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Description Absorption Costing Marginal Costing

Focus Net Profit Contribution
Product Costing Only Variable
Both Fixed & Variable
& Inventory (Manufacturing & Non-
Manufacturing Costs
Valuation manufacturing) Cost
Treatment of Manufacturing Fixed Cost Considered as a Periodic
Fixed Cost considered as a Product Cost Cost
Based on Function Based on Nature/ Cost
Classification of
(Production, Administration, Behaviour
Expenses
Selling & Distribution (Fixed and Variable)
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Question 1
In a particular month, 20,000 units of Biscuits were produced and 18,000
units were sold.
The costs and revenue were as follows:
Sales 90,000
Production Costs
Variable 35,000
Fixed 15,000
Admin + Selling overheads
Fixed 25,000
Prepare the Statement of Profit or Loss based on Absorption and Marginal Costing
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Question 1

Statement of Profit or Loss based on Absorption Costing

Sales
(-) Cost of Sales
Cost of Production
(-) Closing Inventory
Gross Profit
Admin & Selling O/Hs
Net Profit
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Question 1
Statement of Profit or Loss based on Marginal Costing
Sales
(-) Variable Manufacturing Costs
(-) Closing Inventory
Contribution
Fixed Manufacturing Costs
Fixed Non-manufacturing Costs
(Admin + Selling O/Hs)
Net Profit
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Question 2
Following are the sales and production details of ABC Ltd. for two financial years:

Year 1 Year 2
No. of units produced 1,500 1,500
No. of units sold 1,200 1,800
Selling Price per unit Rs. 6.00 Rs. 6.00
Variable Production Cost per unit Rs. 4.00 Rs. 4.00
Fixed Cost Rs.2,000 Rs. 2,000
• There were no opening inventories at the beginning of Year 1.
• Fixed Cost of Rs. 2,000 per year includes, Rs. 1,500 Fixed Production Costs.
Compute the profit for each period under Absorption and Marginal Costing
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Question 2
Statement of Profit or Loss based on Absorption Costing
Year 1 Year 2
Sales
(-) Cost of Sales
Opening Inventory
Cost of Production
Variable
Fixed
(-) Closing Inventory
Gross Profit
Fixed non-manufacturing costs
Net Profit

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Question 2
Statement of Profit or Loss based on Marginal Costing

Year 1 Year 2
Sales
(-) Cost of Sales
Opening Inventory
Cost of Production
Variable
(-) Closing Inventory
Contribution
Fixed non-manufacturing costs
Net Profit

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Thank You

Minoli Jayasekera MBA (PIM-SJP), B.Sc. (Acct.) Hons., ACA, ACMA (UK), CGMA (UK), ACMA (SL)
077 984 8414 minoli.jayasekera@gmail.com
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