Marginal Costing Vs. Absorption Costing
The difference between marginal costing & absorption costing is as below:
- Under marginal costing: for product costing & inventory valuation, only variable cost is considered whereas, under absorption costing; for product costing & inventory valuation, both fixed cost & variable cost are considered.
- Under marginal costing, there is a different treatment of fixed overhead. Fixed cost is considered as period cost & by Profit/Volume ratio (P/V ratio), profitability of different products is judged. On the other hand, under absorption costing system, the fixed cost is charged to cost of production. A reasonable share of fixed cost is to be borne by each product & thereby subjective apportionment of fixed overheads influences the profitability of product.
- Under marginal costing, the presentation of data is so oriented that total contribution & contribution from each product gets highlighted. Under absorption costing, the presentation of cost data is on conventional pattern. After deducting fixed overhead, the net profit of each product is determined.
- Under marginal costing, the unit cost of production does not get affected by the difference in the magnitude of opening stock & closing stock. Whereas, under absorption costing, due to the impact of the related fixed overheads, the unit cost of production get affected by the difference in the magnitude of opening stock & closing stock.
Effects of opening & closing stock on profit:
When income statements under absorption costing & marginal costing are compared, the under mentioned points should be considered:
- The results under both the methods will be same in situations where sales & production coincide i.e., there is neither opening stock nor closing stock.
- Profit under absorption costing will be more than the profit under marginal costing, when closing stock is more than the opening stock. The reason behind this is that, under absorption costing, a portion of fixed overhead, instead of being charged to the current period, is charged to the closing stock & carried over to the next period.
- Profit shown under absorption costing will be lower than the profit shown under marginal costing, when closing stock is less than the opening stock. The reason behind this is that, under absorption costing, to the current period, a portion of fixed cost related to previous year is charged.
Reconciliation of results of absorption costing & marginal costing:
When comparison of the results of absorption costing & marginal costing is undertaken, the adjustments for under- absorbed & / or over absorbed overheads becomes necessary. Under absorption costing, on the basis of normal level of activity, the fixed overhead rate is predetermined. A situation of under-absorption &/or over-absorption arises when there is a difference between actual level of activity & normal level of activity.
(i) Under-absorbed fixed overhead = Excess of normal level of activity over actual level of activity * Fixed overhead rate per unit.
If there is under-absorption, the profit under absorption costing, before comparison with profit as per marginal costing, should be reduced with under-absorbed fixed overheads. Alternatively, by adding the under-absorbed fixed overhead to the cost of production, the same objective can be achieved.
(ii) Over absorbed Fixed overhead = Excess of actual level of activity over normal level of activity * Fixed overhead rate per unit.
If there is over absorption, then before the comparison of profit as per absorption costing with the profit as per marginal costing, with over-absorbed fixed overheads, the profit under absorption costing should be increased. Alternatively, by reducing the over-absorbed fixed overhead from the cost of production, the same objective can be achieved.
Problem 1: For a particular product, the following cost data is given:
Per
unit ($)
Selling Price 20
Variable cost 12
Fixed cost 4
Normal production 52000
units
For the four consecutive periods, the following additional data are given:
Period 1 Period 2 Period 3 Period 4 Total
Units Units Units Units Units
Opening stock - - 12000 4000 -
Production 52000 60000 48000 60000 220000
Sales 52000 48000 56000 64000 220000
Closing stock - 12000 4000 - -
Prepare a statement showing the profit for different periods under both marginal costing method & absorption costing method.
Solution: Under Marginal Costing
Particulars Period 1($) Period 2 ($) Period 3($) Period 4($) Total ($)
Sales – (i) 1040000 960000 1120000 1280000 4400000
Opening stock - - 144000 48000 -
Production 624000 720000 576000 720000 2640000
Total 624000 720000 720000 768000 2640000
Less: Closing stock -___ 144000 48000 - -____
Cost of goods
Sold (ii) 624000 576000 672000 768000 2640000
Contribution
(i) –(ii) 416000 384000 448000 512000 1760000
Less: Fixed Cost
52000 units @ 4 208000 208000 208000 208000 832000
Profit 208000 176000 240000 304000 928000
Under Absorption Costing
Particulars Period 1 Period 2 Period 3 Period 4 Total
($) ($) ($) ($) ($)
Sales – (i) 1040000 960000 1120000 1280000 4400000
Opening stock @
$ 16 per unit - - 192000 64000
Cost of Production
$ 16 per unit 832000 960000 768000 960000 3520000
Total 832000 960000 960000 1024000 3520000
Less: Closing stock
@ $ 16 per unit - 192000 64000 - -__
Cost of goods sold
(Actual) 832000 768000 896000 1024000 3520000
Less: Over-absorbed - 32000 32000 64000
Overheads (Notes
1) (Notes
3)________
832000 736000 896000 992000 3456000
Add: Under-absorbed 16000 16000
Overheads (Notes
2)____________________
Cost of Sales after
adjusting under/over
absorbed overheads
- (ii) 832000 736000 912000 992000 3472000
Profit [(i) – (ii) 208000 224000 208000 288000 928000
Notes: The following adjustments should be carried out for the purpose of comparison
of results of absorption costing & marginal costing:
- The normal capacity is 52000 units. Actual production during the period is 60000 units. That means there is over-absorption of fixed overhead amounting $ 32000 [(60000 units – 52000 units) * $4].
- Actual production is 4 8000 units which are less than normal production by 4000 units. That means there is under-absorption of fixed overhead amounting $ 16000 [(52000 units – 48000 units) * $4].
- Actual production is 60000 units which are more than normal production by 8000 units. That means there is over-absorption of fixed overhead amounting $ 32000 [(60000 units – 52000 units) * $4].
There is difference of profits under both the methods. The reasons of such difference are:
- Period 1: During this period, since no opening or closing stock is there,
there is no difference in profit figures under both the methods.
- Period 2: During this period, profit under Absorption costing is more
than that of Marginal costing by $ 48000. This is due to the fact that fixed cost
of 12000 units @ $ 4 is being carried forward for the next year.
- Period 3: During this period, profit under Absorption costing is less
than that of Marginal costing by $ 32000. This is due to the fact that by 8000
units opening stock is more than that of closing stock. As a result, to the cost
of production of current year, a portion of last year’s fixed overhead is
being charged.
- Period 4: During this period, profit under Absorption costing is less than that of Marginal costing by $ 16000. This is due to the fact that to the cost of production of current years, the fixed overhead relating to opening stock is being charged.
Presentation of data:
The difference of presenting the data under marginal costing & absorption costing is summarized in the under mentioned table:
Marginal Costing Absorption
Costing
Sales XXX Sales XXX
Less: Variable Cost Less:
Manufacturing cost of
Manufacturing XXX goods
sold (including
Administration XXX fixed
manufacturing
Selling XXX XXX overheads) XXX
Contribution XXX XXX
Less: Fixed cost Less:
Administration &
Manufacturing XXX Selling
Expenses XXX
Administration XXX Profit XXX
Selling XXX XXX
Profit XXX
Note: Profits figure under the two methods will be different,
if there are opening & closing inventories.
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