Absorption costing and marginal costing are two costing approaches that determine what should be the cost of a product. Let’s understand their differences.
Absorption costing is allocating (absorbing) the cost of a product over the units produced and sold.
It is possible to calculate an absorption cost through direct and indirect methods. Absorption costing for manufacturing organizations is a more advanced approach that companies can employ to allocate the costs of products produced and sold.
The marginal cost of a business or a product is the additional cost that a company has to incur when producing one more unit. In economics, marginal costing is also known as variable costing.
In business strategy, marginal costing is particularly significant in pricing decisions and determining target return on investment (ROI) and sales volume.
The following points of difference between absorption costing and marginal costing.
|1. All costs fixed and variable included for ascertaining
|1. Only variable costs are included. Fixed costs are recovered from contribution.
|2. Difference unit costs are obtained at different output levels because fixed expenses remain the same.
|2. The marginal cost per unit will remain at the same rate at different output levels because variable expenses vary in the same proportion in which output varies.
|3. The difference between sales and the total cost is profit.
|3. The difference between sales and marginal cost in contribution and the difference between contribution and fixed cost is profit or loss.
|4. A portion of fixed cost is carried forward to the next period because the closing stock of work in progress and fished goods are valued at the cost of production, which is included in the fixed cost.
In this way, the cost of a particular period is vitiated because fixed cost being a period cost, should be charged to the period concerned and should not be carried over to the next period.
|4. The stock of work in progress and finished goods are valued at a marginal cost which does not include the fixed cost. The fixed cost of a particular period is charged to that same period and is not carried over to the next period by including it in closing stock. Being so, the costs of a particular period are not vitiated.
|5. If the stock of working in progress and finished good increase during a period, absorption costing will reveal more profit than marginal costing.
When such stocks decrease, less profit is shown by absorption costing than marginal costing because under this technique of costing; closing stock is valued at higher figures as explained above in point (4), i.e., closing stock is valued at a total cost which is inclusive of variable cost and fixed cost.
|5. If the stock of work- in progress and finished goods increase during a period, marginal costing reports less income than absorption costing, but when such stock decrease, the technique of marginal costing reveals more information than absorption costing.
The difference in profit as arrived at under absorption costing and marginal costing due to the difference in accounting for fixed overhead. The technique of marginal costing values closing stock at their variable costs and does not include an element of fixed costs.
|6. The 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.
|6. Only variable costs are charged to products; the marginal cost technique does not lead to over or under4 absorption of fixed overheads.
|7. Absorption costing is not very helpful in taking a managerial decisions such as whether to accept the export order, whether to buy or manufacture, the minimum price to be charged during and depression etc.
|7. The marginal costing technique is beneficial in managerial decisions because it considers the additional cost involved, only assuming fixed expenses remain constant.
|8. Costs are classified according to operational bases such as production, office and administrative, and selling and distribution.
|8. Costs are classified according to the behaviour of costs, i.e., fixed and variable costs.
|9. Absorption costing fails to establish a relationship between cost, volume, and profit, as costs are seldom classified into fixed and variable.
|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.