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Absorption and

Marginal
Costing

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Definition
• Absorption costing
• Marginal costing

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Absorption costing • It is costing system which treats all manufacturing costs including both the fixed and variable costs as product costs. 3 .

The fixed manufacturing overheads are regarded as period cost. 4 .Marginal costing • It is a costing system which treats only the variable manufacturing costs as product costs.

Presentation of costs on income statement 5 .

expenses X Other fixed expenses X X Net Profit X 6 .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 variable expenses X Total contribution expenses X Variable and fixed manufacturing Net Profit Less: Expenses Fixed selling expenses X Fixed admin.manufacturing expenses Variable selling expenses X X Variable admin. expenses X Other expenses X Less: variable non.

Difference between absorption and marginal costing 7 .

Fixed manufacturing overheads will be incurred regardless there is production or not 8 .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.

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 9 .

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.Absorption costing Marginal costing Reported If the production = Sales. AC profit < MC profit As the previously deferred factory overhead will be released and charged as cost of goods sold 10 .

Arguments for marginal costing 11 .

it provides useful information for break-even analysis that indicates whether fixed costs can be covered with the change in sales volume 12 .• 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.

Cost Volume Profit Analysis .

Types of Costs Variable Fixed Semi Variable .

Minutes Talked .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.

Per Minute Telephone Charge Variable costs per unit do not change as activity increases. For example. 10 cents per minute. Minutes Talked .Variable Cost Per Unit The cost per long distance minute talked is constant.

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. ta o T xe i lm os c d t Variable Utility Charge Fixed Monthly Utility Charge Activity .

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

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

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