Differences between Absorption Costing and Marginal Costing¶
Absorption costing and marginal costing are two distinct methods used in accounting for the costs associated with the production of goods. Below is a table that highlights the key differences between these two costing methods:
| # | Absorption Costing | Marginal Costing |
|---|---|---|
| 1 | Both fixed and variable costs are considered for product costing and inventory valuation. | Only variable costs are considered for product costing and inventory valuation. |
| 2 | Fixed costs are charged to the cost of production. Each product bears a reasonable share of fixed cost and thus the profitability of a product is influenced by the apportionment of fixed costs. | Fixed costs are regarded as period costs. The profitability of different products is judged by their P/V ratio. |
| 3 | Cost data are presented in a conventional pattern. Net profit of each product is determined after subtracting fixed cost along with their variable cost. | Cost data are presented to highlight the total contribution of each product. |
| 4 | The difference in the magnitude of opening stock and closing stock affects the unit cost of production due to the impact of related fixed cost. | The difference in the magnitude of opening stock and closing stock does not affect the unit cost of production. |
| 5 | In case of absorption costing the cost per unit reduces, as the production increases as it is fixed cost which reduces, whereas, the variable cost remains the same per unit. | In case of marginal costing the cost per unit remains the same, irrespective of the production as it is valued at variable cost. |
Detailed Explanation¶
Absorption Costing¶
Absorption costing is a comprehensive approach to product costing that includes both variable and fixed costs. It provides a full cost per unit by allocating a portion of fixed costs to each unit produced. This means that the profitability of each product can be affected by how fixed costs are allocated. Moreover, changes in inventory levels can impact the reported cost of goods sold because the fixed costs associated with the production are spread across the units in stock.
Marginal Costing¶
Marginal costing, on the other hand, considers only variable costs when costing products. Fixed costs are treated as period costs and are written off against the profits of the period in which they are incurred. The P/V ratio is a crucial metric in marginal costing, as it measures the profitability of products based on the contribution they make over variable costs. Unlike absorption costing, changes in inventory levels do not affect the unit cost of production in marginal costing because fixed costs are not allocated to inventory.
Comparison¶
The choice between absorption costing and marginal costing can have significant implications for financial reporting, tax calculations, and business decision-making. While absorption costing gives a more inclusive picture of total production costs, marginal costing can provide clearer insight into the incremental cost of producing one more unit and is often used for decision-making and planning purposes.
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