Absorption and marginal costing

1

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.

2

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 3 .

Presentation of costs on income statement 4 .

manufacturing expenses Variable selling expenses Variable admin. expenses Other fixed expenses Net Profit X X X X 5 . expenses X Other expenses X Marginal costing $ X X X X Variable and fixed manufacturing Net Profit X Sales Less: Variable cost of Goods sold Product contribution margin $ X X X Less: variable non.Trading and profit ans loss account Absorption costing Sales Less: Cost of goods sold Gross profit Less: Expenses Selling expenses X Admin. expenses Other variable expenses Total contribution expenses X X X X Less: Expenses Fixed selling expenses Fixed admin.

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 6 .

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 7 .

Marginal costing 8 .

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 9 .

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 11 .

Difference between absorption and marginal costing 12 .

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. Fixed manufacturing overheads will be incurred regardless there is production or not 13 . It is believed that only the variable costs are relevant to decisionmaking.

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 14 .

AC profit = MC Profit profit If Production > Sales. AC profit < MC profit As the previously deferred factory overhead will be released and charged as cost of goods sold 15 .Absorption costing Marginal costing Reported If the production = Sales. AC profit > MC profit As some factory overhead will be deferred as product costs under the absorption costing If Production < Sales.

Argument for absorption costing 16 .

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 17 .   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.

Arguments for marginal costing 18 .

it provides useful information for break-even analysis that indicates whether fixed costs can be converted with the change in sales volume 19 . marginal costing does not ignore fixed costs in setting the selling price.  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. On the contrary.

 Thanks…  Any questions…. 20 ..