Absorption Costing and Marginal Costing

The upcoming discussion will update you about the difference between absorption costing and marginal costing.  

Difference # Absorption Costing:

1. All costs fixed and variable are included for ascertaining the cost.

2. Different unit costs are obtained at different levels of output because of fixed expenses remaining same.

3. Difference between sales and total cost is profit.

4. A portion of fixed cost is carried forward to the next period because closing stock of work-in-progress and finished goods is valued at cost of production which is inclusive of fixed cost. In this way costs of a particular period are vitiated because fixed cost being period cost should be charged to the period concerned and should not be carried over to the next period.

5. If stocks of working-in-progress and finished goods increase during a period, absorption costing will reveal more profits as compared to marginal costing.

When such stocks decrease, less profits are shown by absorption costing than marginal costing because under this technique of costing, closing stocks are valued at higher figures as explained above in point (4), i.e., closing stocks are valued at total cost which is inclusive of variable cost and fixed cost.

6. Apportionment of fixed expenses on an arbitrary basis gives rise to over or under absorption of overheads which ultimately makes the product cost inaccurate and unreliable.

7. Absorption costing is not very helpful in taking managerial decisions such as whether to accept the export order or not, whether to buy or manufacture, the minimum price to be charged during the depression etc.

8. Costs are classified according to functional basis such as production cost, office and administrative cost and selling and distribution cost.

9. Absorption costing fails to establish relationship of cost, volume and profit as costs are seldom classified into fixed and variable.

Difference # Marginal Costing:

1. Only variable costs are included. Fixed costs are recovered from contribution.

2. Marginal cost per unit will remain same at different levels of output because variable expenses vary in the same proportion in which output varies.

3. Difference between sales and marginal cost is contribution and difference between contribution and fixed cost is profit or loss.

4. Stock of work-in-progress and finished goods are valued at marginal cost which does not include fixed cost. Fixed cost of a particular period is charged to that very period and is not carried over to the next period by including it in closing stock. Being so, costs of a particular period are not vitiated.

5. If stocks of work-in-progress and finished goods increase during a period, marginal costing reports less income than absorption costing. But when such stocks decrease, the technique or marginal costing reveals more information than absorption costing.

The difference in profits as arrived at under absorption costing and marginal costing is due to difference in accounting for fixed overheads. The technique of marginal costing values closing stocks at their variable costs and does not include element of fixed costs.

6. Only variable costs are charged to products, marginal cost technique does not lead to over or under absorption of fixed overheads.

7. Technique of marginal costing is very helpful in taking managerial decisions because it takes into consideration the additional cost involved only assuming fixed expenses remaining constant.

8. Costs are classified according to the behaviour of costs i.e., fixed costs and variable costs.

9. Cost, Volume and Profit (i.e., CVP) relationship is an integral part of marginal cost studies as costs are classified into fixed and variable costs.