Absorption Costing technique is also termed as full cost method. In Absorption Costing, the cost of a product is determined after considering both Fixed and Variable Costs. While under Marginal Costing only variable costs are charged to production, Fixed costs are ignored. This is on the basis that for additional output only Variable Costs are incurred since Fixed Costs remain constant. There is, therefore, no reason to burden the additional output with the share of fixed overheads, otherwise, it will give wrong idea about the likely profit to be earned on additional sales. Marginal Costing system differs from Absorption Costing system in two respects:
- Recovery of overheads – In case of Absorption Costing, both fixed and variable overheads are charged to production. On the other hand, in Marginal Costing, only variable overheads are charged to production while fixed overheads are transferred in full to the costing and profit and loss account. Thus in case of marginal costing, there is under recovery of overheads since only variable overheads are charged to production.
- Valuation of Stocks – In case of Absorption Costing, stocks of work-in-progress and finished goods are valued at work cost and total cost of production, respectively. The works cost or cost of production so used includes the amount of fixed overheads also. In case of Marginal Costing, only variable costs are considered while computing the value of work-in-progress or finished goods. Thus, the closing stock in Marginal Costing in under-valued as compared to absorption costing. This is also results in carrying over the fixed overheads of one period to the next period