1. 2.

3.

ABSORPTION COSTING VS MARGINAL COSTING REASONS FOR SELECTING THE TOPIC PRACTICAL APPLICABILITY . NECESSARY FOR STARTING THE BUSINESS. WIDE SCOPE.

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CENTER NAME: KANDIVALI(E),THAKUR VILLAGE BATCH TIMING: 7:00AM TO 12:00PM BATCH COMMENCMENT:

NAME
1. 2. 3. 4. 5.

WRO NUMBER
WRO 0355560

ABHISHEK BHANUSHALI ANIRUDH CHATURVEDI HARSH PATEL KARAN BHANUSHALI VIJAY TIWARI

GROUP LEADER: CONTACT NUMBER:

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COSTING
DEFINITION :


COSTING is defined as the technique and process of ascertaining costs.

In simple words, costing means to find out cost of a final product manufactured. Cost means total expenses incurred from the stage of buying of raw materials to the stage of selling of final products.

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ELEMENTS OF COST
COST

MATERIALS

LABOUR

EXPENSES

OVERHEADS

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MATERIALS a> Direct Materials: Materials which are present in the finished product(cost object) of can be economically identified in the product are called direct materials.
1.

b>Indirect Material: Materials which do not normally form part of the finished product(cost object) are known as indirect materials. These are: 1.Stores used for maintaining machines and building (lubricants, cotton waste, bricks etc.). 2.Stores used by service departments like power house, boiler house, canteen etc.
2.

LABOUR

a> Direct Labour: Labour which can be economically identified or attributed wholly to a cost object is called direct labour. b>Indirect Labour: Labour costs which cannot be allocated but can be apportioned to or absorbed by cost units or cost centers is known as indirect labour.
4(A)

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EXPENSES a>Direct Expenses: It includes all expenses other than direct material or direct labour which are specially incurred for a particular cost object and can be identified in an economically feasible way. b>Indirect Expenses: Expenses other than direct expenses are known as indirect expenses, that cannot be directly, conveniently and wholly allocated to cost centers. Factory rent and rates, insurance of plant and machinery, power, light, heating, repairing, telephone etc.; are examples of indirect expenses.
3.

OVERHEADS It is the aggregate of indirect material costs, indirect labour costs and indirect expenses. The main groups into which overheads may be subdivided are the following: a>.Production or Works overheads: Indirect expenses which are incurred in the factory and for the running of the factory. Eg: Rent, Power etc.
4.

b>.Administration overheads: Indirect expenses related to management and administration of business. Eg: Office Rent, Lighting, Telephone etc.

c>.Selling overheads: Indirect expenses incurred for marketing of a commodity. Eg: Advertisement expenses. d>.Distribution overheads: Indirect expenses incurred in dispatch of the goods. Eg: Warehouse charges, Packing & loading charges.
4(B)

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TYPES OF COSTING:
1)

2) 3) 4) 5) 6) 7)

Job costing Contract costing Process costing Batch costing Operating costing Marginal costing Absorption costing are different types of costing method. In each of the costing methods, various techniques may be used to ascertain cost, depending on the management requirement.
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WHY COSTING HAS TO BE DONE?

Determination of selling price:

Business enterprises run on a profit making basis. It is thus necessary that the revenue should be greater than the costs incurred. Cost accounting provides the information regarding the cost to make and sell the product or services produced. Though the selling price of a product is also influenced by market conditions, which are beyond the control of any business, it is still possible to determine the selling price within the market constraints, hence cost plays a dominating role.
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INTRODUCTION TO ABSORPTION COSTING

Under Absorption costing, the fixed overheads are charged to the output to the extent, the output remains unsold i.e. closing stock, its valuation would include not only the variable production cost but also the fixed overheads. This implies that part of the current period's fixed cost is effectively converted into an asset and carried forward and charged to the next period. Likewise the opening stock valuation also includes the fixed overheads of previous period.

INTRODUCTION TO MARGINAL COSTING

Under marginal costing , the fixed costs are treated as a period cost and do not depend on the output. This implies that irrespective of the budgeted output, the closing stock is valued at the current period variable cost and nothing re enters the cost of the next period.

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In order to get fixed overheads cost per unit, for the purpose of determining the sale price, we need to know the actual fixed overheads and actual level of activity; But the actual overheads and the actual level of activity would be known to us only at the end of the accounting year, whereas the sale price has to be known before the commencement of the accounting year and therefore the actual information cannot be used.

BASIC CHARACTERISTICS OF ABSORPTION COSTING

1. Absorption costing technique as against marginal costing technique, lays down artificial link between the budgeted overheads and the budgeted level of activity, to get budgeted overheads charge, which is known as "Absorption rate, recovery rate or application rate." 2.The level of activity can be expressed in terms of output, machine hours, labour hours, labour cost, material cost or prime cost, man-days, etc.

3.Once the absorption rate is developed, every time something is produced, the overheads will be charged at absorption rate.
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METHODS FOR CALCULATING ABSORPTION RATE:

1.Output method= budgeted overheads budgeted output budgeted overheads budgeted no.of machine hours budgeted overheads budgeted labour hours

2.Machine hour rate =

3.Labour hour rate =

4.Labour cost method= budgeted overheads budgeted labour cost 5.Prime cost method= budgeted overheads budgeted prime cost
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BASIC CHARACTERISTICS OF MARGINAL COSTING

The technique of marginal costing is based on the distinction between product costs and period costs. Only the variables costs are regarded as the costs of the products while the fixed costs are treated as period costs which will be incurred during the period regardless of the volume of output. The main characteristics of marginal costing are as follows:
1. All elements of cost are classified into fixed and variable components. Semi-variable costs are also analyzed into fixed and variable elements. 2. The marginal or variable costs (as direct material, direct labour and variable factory overheads) are treated as the cost of product. 3. Under marginal costing, the value of finished goods and work-in-progress is also comprised only of marginal costs. Variable selling and distribution are excluded for valuing these inventories. Fixed costs are Not considered for valuation of closing stock of finished goods and closing WIP. 4. Fixed cost are treated as period costs and is charged to profit and loss account for the period for which they are incurred. 5. Prices are determined with reference to marginal costs and contribution margin. 10

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COST SHEET
Absorption costing Sales Less: Cost of goods sold Gross profit Less: Expenses Selling expenses X Admin. expenses X Other expenses X $ X X X Marginal costing Sales Less: Variable cost of Goods sold Product contribution margin Less: variable non- manufacturing expenses Variable selling expenses Variable admin. expenses Other variable expenses Total contribution expenses Less: Expenses Fixed selling expenses Fixed admin. expenses Other fixed expenses Net Profit th $ X X X

Variable and fixed manufacturing

X X X X

Net Profit

X
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X X X X

EFFECTS ON PROFITS

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REASONS FOR DIFFERENCE IN PROFITS

The above two approaches will compute profit because of the difference in the stock valuation. This difference is explained as follows in different circumstances. 1. No opening & closing stock: in this case, profit/loss under absorption & marginal costing will be equal. 2. When opening stock is equal to closing stock: In this case, profit/loss under two Approaches will be equal provided the fixed cost element in both the stocks is of the same amount. 3. When closing stock is more thane opening stock: in other words, when the production during the year are more than sales, then profit as per absorption approach. the reason behind this difference is part of fixed overhead included in closing stock value is carried forwarded to next accounting period 4. When opening stock is more than the closing stock: in other words when production is less than sales, profit shown by marginal costing will be more than absorption costing. this is because a part of fixed cost a part of fixed cost is added to the current year's cost of goods sold in the form of opening stock

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ABSORPTION COSTING
ADVANTAGES

LIMITATIONS
Absorption costing does not understand the importance of fixed costs. In absorption costing, fixed costs are absorbed to unit, therefore it is hard to distinguish between variable and fixed costs.

Fixed costs are recovered fixed costs are incurred in order to make output so it is only fair to charge all output with a share of these costs Ensures that costs are fully recovered Encourages cost consciousness It is fair that it uses appropriate methods for each overhead Identifies total costs this is useful where pricing is on cost plus basis Identifies the profitability of different products and service
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And also, the variability of profit will cause confusion, the reason is that the net profit varies with both sales and stock changed under absorption costing.

MARGINAL COSTING
ADVANTAGES
Proper recovery of overheads. Overheads are recovered in costing on the basis of pre determined rates. If fixed overheads are included on basis Of pre determined rates, there will be under recovery of overhead's if production is less or over head' are more. There

LIMITATIONS
Difficulty incrassating fixed & variable elements It is difficult to classify the expenses into fixed & variable expenses. Most of the expenses are neither totally fixed nor totally variable

Shows realistic profit. Advocates of marginal costing argues that under the marginal costing technique, the stock of finished goods& work in Progress is carried on marginal cost basis &the fixed expenses are return off to profit & loss a/c as period cost. This shows true profit of the period
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Unpredictable nature of cost Some of the assumption regarding the behavior of various costs is not necessarily true in a realistic situation. For example: the assumption That fixed cost will remain constant throughout is not correct. Fixed cost may change from one period to another. For example salaries

Now after understanding each method, we simultaneously distinguish between both the methods

DISTINCTION
ABSORPTION COSTING MARGINAL COSTING

1. Fixed overheads converted into product cost. 2. Fixed overheads do not get written off as part of the reenters stock. 3. Wrong profit, therefore wrong dividend decisions.

1. Fixed Overheads converted into period cost 2. Fixed overheads get completely written off.

3.

True profit & therefore correct dividend decision.

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DISTINCTION
ABSORPTION COSTING MARGINAL COSTING

4. Stock are valued at total cost. 5. Book keeping technique 6. Allowed in costing & financial A/c to make books of A/cs.

4. Stock are valued at variable cost. 5. Decision making technique 6. Allowed only in costing to make books of A/cs as revised AS-2 does not permit use of marginal costing in financial A/cs.

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BIBLIOGRAPHY
 www.google.co.in  www.businesstudent .com  IPCC Cost Accounting Module

THANK YOU
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