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Difference between Absorption Costing and Marginal Costing

Difference between Absorption Costing and Marginal Costing

Difference between Absorption Costing and Marginal Costing

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

 

Comparison Chart of Absorption Costing and Marginal Costing

BASIS FOR COMPARISONMARGINAL COSTINGABSORPTION COSTING
MeaningA decision making technique for ascertaining the total cost of production is known as Marginal Costing.Apportionment of total costs to the cost center in order to determine the total cost of production is known as Absorption Costing.
Cost RecognitionThe variable cost is considered as product cost while fixed cost is considered as period costs.Both fixed and variable cost is considered as product cost.
Classification of OverheadsFixed and VariableProduction, Administration and Selling & Distribution
ProfitabilityProfitability is measured by Profit Volume Ratio.Due to the inclusion of fixed cost, profitability gets affected.
Cost per unitVariances in the opening and closing stock does not influence the cost per unit of output.Variances in the opening and closing stock affects the cost per unit.
HighlightsContribution per unitNet Profit per unit
Cost dataPresented to outline total contribution of each product.Presented in conventional way.

 

Key Differences Between Absorption Costing and Marginal Costing

The following are the major differences between Absorption Costing and Marginal Costing.

  1. The costing method in which variable cost is apportioned exclusively, to the products is known as Marginal Costing. Absorption Costing is a costing system in which all the costs are absorbed and apportioned to products.
  2. In Marginal Costing, Product related costs will include only variable cost while in the case of Absorption costing, fixed cost is also included in product related cost apart from variable cost.
  3. Marginal Costing divides overheads into two broad categories, i.e. Fixed Overheads and Variable Overheads. Look at the other term Absorption costing, which classifies overheads in the following three categories Production, Administration and Selling & Distribution.
  4. In marginal costing profit can be ascertained through the help of Profit Volume Ratio [(Contribution / Sales) * 100]. On the other hand, Net Profit shows the profit in case of Absorption Costing.
  5. In Marginal Costing variances in the opening and closing stock will not influence the per unit cost. Unlike Absorption Costing, where the variances between the stock at the beginning and the end will show its effect by increasing/decreasing per unit cost.
  6. In marginal costing, the cost data is presented to outline total cost of each product. On the contrary, in absorption costing, the cost data is presented in traditional way, net profit of each product is ascertained after deducting fixed cost along with their variable cost.

 

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November 28, 2014
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