I.

Introduction:
In order to effectively manage a business's finances and accounting, costs must be
classified. Unfortunately, not everyone has a firm knowledge of the ideas of product cost
and period cost between the two cost systems of marginal costing and absorption costing.
This may result in errors when determining prices, valuing goods, and analyzing the
company's profits. The distinctions between the ideas of product cost and period cost in
the marginal costing and absorption costing systems will be made clear through the use of
examples and supporting arguments in this essay. You will learn more about these two
cost methods in this essay, as well as how to apply them to effectively calculate earnings
and make wise business decisions.

II. Definition of product cost, period cost, manufacturing cost and non-manufacturing
cost:
Firstly, we need to clearly understand the concepts of product cost and period cost:
 Product cost is the total amount of expenses allocated to the company's product or
service to produce it, including both direct and indirect costs. Product costs may
include material costs, labor costs, management costs, rent, utilities, office
supplies, insurance fees, and other costs related to the production of the product or
the provision of the service.

 Period cost is costs incurred by a business over an extended period of time that are
not directly tied to the cost of manufacturing a good or offering a service. This
could involve expenses for management, marketing, and advertising, finance, rent,
administrative staff pay, and other operational expenses.

The primary distinction between these two ideas is that whereas product cost solely
comprises direct and indirect expenses associated with making the product, period cost
also includes direct and indirect costs associated with production.

 Production cost is the total amount of expenses allocated directly to the company's
product or service, including material costs, direct labor, and other costs related to
producing the product or providing the service.

 Non-production cost is the expenses that are not direct costs of producing the
product or providing the service. This may include management costs, marketing
and advertising costs, finance costs, rent costs, administrative staff salaries, and
other costs related to business operations

III. Cost classification and product evaluation according to marginal and absorption cost
methods:
1. The classification of costs using marginal costing and absorption costing methods can
be demonstrated as follows:
Marginal costing method: Marginal costing is a method of calculating the cost of a
product by considering only the variable costs (costs that vary with the level of
production) in the product cost. Fixed costs (costs that do not vary with the level of
production) are considered the cost of general business operations and are not included in
the product cost. This method is often used for short-term production management.

Absorption costing method: Absorption costing is a method of calculating the cost of a

product by including both variable and fixed costs in the product cost. Fixed costs are
allocated to each product based on a predetermined allocation ratio (such as based on the
number or value of products). This method is often used for both short-term and long-
term product cost calculation.

2. Evaluate a product using the marginal costing and absorption costing methods:

In management accounting, there are two cost classification and product costing methods:
marginal costing and absorption costing. Each technique has pros and cons that must be
considered in order to be employed effectively for the particular business goals of a
company.

The marginal costing method is frequently used for short-term production management
since it only accounts for variable costs in the cost of the product, while fixed costs are
taken into account as operating expenses for the entire business. Utilizing this strategy
makes it simple for businesses to determine the costs of products and plan immediate
production. However, it does not account for actual product costs and could skew the
company's estimation of profits.

However, the absorption costing method accounts for both variable and fixed expenses
when determining the price of a product. This makes it possible for businesses to
calculate the true profit from the product and helps represent the total production
expenses. This approach is more appropriate for determining the profitability of a
company because it is frequently used to determine the cost of a product over both the
short and long term.

The absorption costing approach does, however, have significant drawbacks. In

particular, when the allocation rates do not effectively reflect the changes in fixed costs
based on production levels, assigning fixed costs to each product based on predetermined
allocation rates might result in errors in the product cost assessment.

As a result, it is important to carefully carry out and use the absorption costing method
and marginal costing methods when analyzing a product. The marginal costing method is
more appropriate if a corporation wishes to control and assess the product's profit over
the short term. The absorption costing approach, however, is a preferable option if a
corporation wishes to assess the cost and profit of the product in greater detail and
broadly in both the short and long terms.

A corporation must make sure that the allocation of fixed costs to the product is
acceptable and accurately reflects the changes in fixed costs depending on production
levels in order to employ the absorption costing method successfully. As a result, in this
strategy, it's essential to carefully analyze the manufacturing expenses and create
production projections.

Example: Let's assume a bread production company that uses the marginal cost pricing
method to calculate the cost of their bread products. Variable costs such as raw materials,
labor, and energy are included in the cost of the product, while fixed costs such as rent,
management expenses, and the director's salary are considered as the company's overhead
costs.
The cost of producing one loaf of bread is as follows:
 Raw materials: 2,000 VND
 Labor: 500 VND
 Energy: 200 VND
 Total variable cost: 2,700 VND
If the company wants to calculate the cost of the product and short-term profit, the
marginal cost pricing method is appropriate. The cost of the bread product will be 2,700
VND, and if the company wants to make a profit of 20% on each loaf of bread, the
selling price will be: 2,700 VND x 1.2 = 3,240 VND
Therefore, the company will sell each loaf of bread at a price of 3,240 VND.
However, if the company wants to calculate the actual profit from the product, the
absorption cost pricing method is more appropriate. Fixed costs such as rent,
management expenses, and the director's salary are also included in the cost of the bread
product. Suppose the company's fixed costs are 1,000 VND per loaf of bread, the cost of
the bread product will be:
 Raw materials: 2,000 VND
 Labor: 500 VND
 Energy: 200 VND
 Fixed costs: 1,000 VND
 Total cost: 3,700 VND
The selling price required to ensure a 20% profit on each loaf of bread will be: 3,700
VND x 1.2 = 4,440 VND
Therefore, the company will sell each loaf of bread at a price of 4,440 VND.

III. Mistake in profit analysis when managers consider a special order.

An important phase in determining product costs and controlling a company's spending is
cost classification:
1. The absorption cost method is a widely used cost allocation method in traditional
industries. All production expenses, including direct and indirect expenses, are assigned
to the product using this method. Direct costs are expenses incurred during the actual
manufacture of the good, such as the price of materials and labor. Indirect costs, on the
other hand, include expenses such as administration costs, maintenance costs, rental
prices, and other support expenditures that are not directly associated with the product.

The absorption cost method allocates indirect costs based on the consumption rate of
each product. In other words, indirect costs are allocated to the product based on the
percentage of consumption of that product compared to the total number of products
produced. The absorption cost method allows a business to calculate the product cost
most thoroughly, from direct costs to indirect costs, to ensure that the product cost is
reasonable and includes all related costs.

The absorption cost allocation approach does, however, have significant drawbacks.
Especially when product output is limited, it might result in product costs that are higher
than actual costs. The distribution of indirect expenses per product will lead to a
substantial increase in the cost of the product if a company only manufactures a small
number of items.

Only direct costs are distributed to the produced final good in the marginal cost allocation
technique. No allocation was provided for indirect costs. Because of this, a company can
determine product costs that only comprise expenses directly connected to the creation of
the finished good, such as material and labor costs. This strategy is suitable for
companies that produce huge quantities of goods in large numbers and may spread
indirect costs across a smaller number of products without considerably increasing the
cost of the final product.

2. The marginal cost classification approach offers benefits as well. Compared to the
absorption cost allocation approach, it makes it easier and faster for firms to compute
product costs. Also, by using this technique, companies can image orders and modify
product costs when output changes.

The marginal cost allocation method does, however, have some drawbacks. Businesses
are unable to fully account for overhead expenses when calculating product costs. As a
result, if a company organization employs marginal cost allocation, the cost of the
product may be underestimated in contrast to its actual amount.

Therefore, depending on the industry and production scale, businesses can choose the
appropriate cost allocation method to calculate product costs and manage costs
effectively. If the business wants to calculate the cost of a product most ultimately,
including indirect costs, the absorption cost allocation method is the more appropriate
method. However, if the business is mass-producing, and the volume is large, the
marginal cost method may be more suitable because it allows for faster and simpler
product costing.

- Example: A cookie manufacturing company has an annual production cost of

$100,000. The company sells 10,000 boxes of cookies at a price of $20 per box. If
the company uses absorption costing, the production cost is allocated to the 10,000
boxes of cookies, so the cost per unit will be $10 per box ($100,000/10,000
boxes). Total revenue will be $200,000 (10,000 boxes x $20 per box), and pre-tax
profit will be $100,000 ($200,000 - $100,000 production cost). However, if the
company uses marginal costing, only the direct costs for each box of cookies will
be calculated, such as the cost of materials, labor, and other direct production
costs. If these direct costs are $8 per box, then the cost per unit will be $18 per box
($10 production cost + $8 direct cost). Total revenue is still $200,000, but pre-tax
profit will decrease to $20,000 ($200,000 - $180,000 total cost). Therefore, if the
company only uses absorption costing, it may overestimate its profit and be overly
confident in determining the selling price of its product.

IV.Conclusion:
To understand the errors in profit measurement when a company earns a profit using the
absorption costing method but incurs a loss using the marginal costing method, we need
to further understand the pricing of products and cost classification in these methods. In
theory, both absorption costing and marginal costing have their own advantages and
limitations. The absorption costing method allows for the allocation of production costs
to each product based on various factors, including indirect costs not directly related to
production, such as management and research and development costs. This strategy
enables businesses to more properly price things and make wiser business choices. The
absorption pricing approach, however, is not without shortcomings. The calculation is
sophisticated and dependent on numerous variables that non-financial professionals may
find challenging to comprehend.

Also, there may be a significant difference between the price of the final product and the
direct cost of manufacturing due to the distribution of expenditures that are not directly
related to production. This may result in incorrect profit evaluation and poor business
judgment. Marginal pricing is simpler and easier to understand. It only calculates the
direct costs associated with production, such as the cost of raw materials, labor costs, and
other direct manufacturing costs. Therefore, this method allows companies to price
products more quickly and easily. However, the marginal method of valuation also has its
drawbacks. Calculating only direct costs may result in ignoring indirect costs such as
administrative or research and development costs. This can lead to product prices being
priced lower than actual costs and profits being overestimated. If a company uses the
absorption costing method and achieves a profit, but if it switches to using the marginal
costing method, the company may find that the product has been priced higher than
previously estimated. Therefore, profits decrease and may lead to losses.