What is Absorption and Marginal Costing. - Managerial Accounting

1. 1
Absorption and marginal costing

2. 2
Introduction
 Before we allocate all manufacturing costs
to products regardless of whether they are
fixed or variable. This approach is known
as absorption costing/full costing
 However, only variable costs are relevant
to decision-making. This is known as
marginal costing/variable costing

3. 3
Definition
 Absorption costing
 Marginal costing

4. 4
Absorption costing
 It is costing system which treats all
manufacturing costs including both the
fixed and variable costs as product costs

5. 5
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

6. 6
Cost
Manufacturing cost Non-manufacturing cost
Direct
Materials
Direct
Labour
Overheads
Finished goods Cost of goods sold
Period cost
Profit and loss account
Absorption Costing
Cost
Manufacturing cost Non-manufacturing cost
Direct
Materials
Direct
Labour
Variable
Overheads
Finished goods Cost of goods sold
Period cost
Profit and loss account
Marginal Costing
Fixed
overhead

7. 7
Presentation of costs on income
statement

8. 8
Trading and profit and 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 Less: variable non- manufacturing
Selling expenses X expenses
Admin. expenses X Variable selling expenses X
Other expenses X X Variable admin. expenses X
Other variable expenses X
Total contribution expenses X
Less: Expenses
Fixed selling expenses X
Fixed admin. expenses X
Other fixed expenses X
Net Profit X Net Profit X
Variable and fixed manufacturing

9. 9
Example

10. 10
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

11. 11
 Required:
 Prepare absorption and marginal costing
statements for the three months

12. 12
Absorption costing

13. 13
January February March
$ $ $
Sales 100000 80000 110000
Less: cost of good sold ($65) 65000 52000 71500
28000 38500
Adjustment for Over-/(under)
Absorption of factory overhead 9000 (3000)
Gross profit 35000 37000 35500
Less: Expenses
Fixed selling overheads 1000 1000 1000
Variable selling overheads 4000 3200 4400
Net profit 30000 32800 30100

14. 14
Marginal costing

15. 15
January February March
$ $ $
Sales 100000 80000 110000
Less: Variable cost of good
sold ($35) 35000 28000 385500
Product contribution margin 65000 52000 71500
Less: Variable selling overhead4000 3200 4400
Total contribution margin 61000 48800 67100
Less: Fixed Expenses
Fixed factory overhead 30000 30000 30000
Fixed selling overheads 1000 1000 1000
Net profit 30000 32800 30100

16. 16
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 20
Direct labour 10
Fixed factory overhead absorbed 30
Variable factory overheads 5
65
Back

17. 17
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
Wk 4:
Variable production cost per unit under marginal costing:
$
Direct materials 20
Direct labour 10
Variable factory overhead 5
35
No fixed factory overhead
Back

18. 18
Difference between absorption
and marginal costing

19. 19
Absorption costing Marginal costing
Treatment for
fixed
manufacturing
overheads
Fixed
manufacturing
overheads are
treated as product
costing. It is
believed that
products cannot be
produced without
the resources
provided by fixed
manufacturing
overheads
Fixed manufacturing
overhead are treated
as period costs. It is
believed that only the
variable costs are
relevant to decision-
making.
Fixed manufacturing
overheads will be
incurred regardless
there is production or
not

20. 20
Absorption costing Marginal costing
Value of
closing stock
High value of
closing stock will be
obtained as some
factory overheads
are included as
product costs and
carried forward as
closing stock
Lower value of
closing stock that
included the variable
cost only

21. 21
Absorption costing Marginal costing
Reported
profit
If the production = Sales, AC profit = MC 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, AC profit < MC profit
As the previously deferred factory overhead
will be released and charged as cost of goods
sold

22. 22
Argument for absorption costing

23. 23
 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, 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

24. 24
Arguments for marginal costing

25. 25
 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, it
provides useful information for break-even analysis
that indicates whether fixed costs can be converted
with the change in sales volume