Management Accounting

F2
Marginal costing is the costing principle where all cost units are valued at Variable production costs (Direct costs+
Variable production overheads) and fixed costs are charged to the income statement .
Under M.C. finished goods are valued at Marginal (variable) Production cost i.e.
 Direct materials
 Direct labour
 Variable production overheads
Contribution refers to the difference between sales revenue and the variable cost of sales
Absorption costing is the costing principle where all cost units are valued at full costs including absorbed fixed
costs.
Advantages of absorption costing
1. Realistic-Includes all costs
2. Stock valuation –In compliance with IAS 2
3. Avoids fluctuation of profits in years of no sale
4. Pricing decisions are made easy
Advantages of Marginal costing
1. Simple to operate
2. Avoids need to apportion fixed costs
3 .Avoids under /over absorption
4. Provides relevant information for decision making

Example 1
The following example will be used to lead you through the various steps in calculating marginal and absorption
costing profits, and will highlight the differences between the two techniques.
Big Woof Co manufactures a single product, the Bark, details of which are as follows.
Per unit $
Selling price 180.00
Direct materials 40.00
Direct labour 16.00
Variable overheads 10.00
Annual fixed production overheads are budgeted to be $1.6 million and Big Woof expects to produce 1,280,000
units of the Bark each year. Overheads are absorbed on a per unit basis. Actual overheads are $1.6 million for the
year.
Budgeted fixed selling costs are $320,000 per quarter.
Actual sales and production units for the first quarter of 20X8 are given below.
January – March
Sales 240,000
Production 280,000
There is no opening inventory at the beginning of January.
Prepare income statements for the quarter, using
(a) Marginal costing
(b) Absorption costing

1 Marginal and absorption costing

 Management Accounting
F2

Marginal costing Absorption costing

$'000 $'000 $'000 $'000
Sales (240,000 x $180) 43,200 43,200
Less Cost of Sales
Opening inventory 0 0
Add Production cost
280,000 x $66 18,480
280,000 x $67.25 18,830
Less Closing inventory
40,000 x $66 (2,640)
40,000 x $67.25 (2,690)
(15,840) 16,140
Add Under absorbed O/H 50
(16,190)
Contribution 27,360
Gross profit 27,010
Less
Fixed production O/H 400 Nil
Fixed selling O/H 320 320
(720) (320)
Net profit 26,640 26,690

Statement to reconcile profit between marginal costing and absorption costing $

Profit under absorption costing 26690
Less: Difference in closing inventory (50)
Add: Difference in opening inventory 0
Profit under marginal costing 26640

2 Marginal and absorption costing