Marginal and Absorption costing

2. • CALCULATE THE CONTRIBUTION OF A PRODUCT
• PREPARE A BREAK-EVEN CHART
• CALCULATE THE BREAK-EVEN POINT, CONTRIBUTION TO SALES RATIO AND MARGIN OF SAFETY
• EXPLAIN THE USE AND LIMITATIONS OF BREAK-EVEN CHARTS
• PREPARE A STATEMENT RECONCILING THE REPORTED PROFIT USING MARGINAL COSTING AND ABSORPTION
COSTING
• IDENTIFY THE USES AND LIMITATIONS OF MARGINAL COSTING
• CALCULATE THE EFFECT OF LIMITING FACTORS ON PRODUCTION.

3. MARGINAL COSTING
THE MARGINAL COST OF AN ITEM IS ITS VARIABLE COST. THE MARGINAL PRODUCTION COST OF AN ITEM IS
THE SUM OF ITS DIRECT MATERIALS COST, DIRECT LABOUR COST, DIRECT EXPENSES COST (IF ANY) AND
VARIABLE PRODUCTION OVERHEAD COST. SO AS THE VOLUME OF PRODUCTION AND SALES INCREASES
TOTAL VARIABLE COSTS RISE PROPORTIONATELY.

4. ABSORPTION COSTING
• ABSORPTION COSTINGIS A METHOD OF BUILDING UP A FULL PRODUCT COST WHICH ADDS DIRECT
COSTS AND A PROPORTION OF PRODUCTION OVERHEAD COSTS BY MEANS OFONE OR A NUMBER OF
OVERHEAD ABSORPTION RATES.

5. ADVANTAGES AND DISADVANTAGES OF
MARGINAL COSTING
ADVANTAGES
• MARGINAL COSTING IS SIMPLE TO
UNDERSTAND.
• BY NOT CHARGING FIXED OVERHEAD TO COST OF
PRODUCTION, THE EFFECT OF VARYING CHARGES
PER UNIT IS AVOIDED.
DISADVANTAGES
• THE SEPARATION OF COSTS INTO FIXED AND
VARIABLE IS DIFFICULT AND SOMETIMES GIVES
MISLEADING RESULTS.
• NORMAL COSTING SYSTEMS ALSO APPLY
OVERHEAD UNDER NORMAL OPERATING VOLUME
AND THIS SHOWS THAT NO ADVANTAGE IS GAINED
BY MARGINAL COSTING.

6. ADVANTAGES AND DISADVANTAGES OF
ABSORPTION COSTING
ADVANTAGES
• IN ABSORPTION COSTING, ITEMS OF STOCK ARE
COSTED TO INCLUDE A ‘FAIR SHARE’ OF FIXED
PRODUCTION OVERHEAD.
• IN ABSORPTION COSTING, ‘ACTUAL’ FULLY
ABSORBED UNIT COSTS ARE REDUCED BY
PRODUCING IN GREATERQUANTITIES.
DISADVANTAGES
• YOU MIGHT HAVE OBSERVED THAT IN ABSORPTION COSTING, A PORTION
OF FIXED COST IS CARRIED OVER TO THE SUBSEQUENT ACCOUNTING
PERIOD AS PART OF CLOSING STOCK. THIS IS AN UNSOUND PRACTICE
BECAUSE COSTS PERTAINING TO A PERIOD SHOULD NOT BE ALLOWED TO BE
VITIATED BY THE INCLUSION OF COSTS PERTAINING TO THE PREVIOUS
PERIOD AND VICE VERSA.
• ABSORPTION COSTING IS DEPENDENT ON THE LEVELS OF OUTPUT WHICH
MAY VARY FROM PERIOD TO PERIOD, AND CONSEQUENTLY COST PER UNIT
CHANGES DUE TO THE EXISTENCE OF FIXED OVERHEAD. UNLESS FIXED
OVERHEAD RATE IS BASED ON NORMAL CAPACITY, SUCH CHANGED COSTS
ARE NOT HELPFUL FOR THE PURPOSES OF COMPARISON AND CONTROL.

7. COMPARISON OF MARGINAL AND
ABSORPTION COSTING
COST RECOGNITION COST RECOGNITION
• THE VARIABLE COST IS CONSIDERED AS
PRODUCT COST WHILE FIXED COST IS
CONSIDERED AS PERIOD COSTS.
• BOTH FIXED AND VARIABLE COST IS CONSIDERED
AS PRODUCT COST.

8. CLASSIFICATION OF OVERHEADS
MARGINAL
• FIXED AND VARIABLE
ABSORPTION
• PRODUCTION, ADMINISTRATION AND SELLING &
DISTRIBUTION

9. PROFITABILITY
MARGINAL
• PROFITABILITY IS MEASURED BY PROFIT
VOLUME RATIO.
ABSORPTION
• DUE TO THE INCLUSION OF FIXED COST,
PROFITABILITY GETS AFFECTED.

10. COST PER UNIT
MARGINAL
• VARIANCES IN THE OPENING AND CLOSING
STOCK DOES NOT INFLUENCE THE COST PER UNIT
OF OUTPUT.
ABSORPTION
• VARIANCES IN THE OPENING AND CLOSING
STOCK AFFECTS THE COST PER UNIT.

12. FORMAT FOR MARGINAL COSTING
SALES REVENUE
LESS MARGINAL COST OF SALES
OPENING STOCK
ADD PRODUCTION COST
TOTAL PRODUCTION COST
LESS CLOSING STOCK
MARGINALCOST OF PRODUCTION
ADD SELLING ADMIN AND DISTRIBUTION COST
MARGINALCOST OF SALES
CONTRIBUTION
LESS FIXED COST
MARGINALCOSTING PROFIT

13. FORMAT FOR ABSORPTION COSTING
SALES
LESS COST OF SALES
OPENING STOCK
VARIABLE COST OF PRODUCTION
FIXED OVERHEAD ABSORBED
LESS CLOSING STOCK
(UNDER) OR LOWER ABSORPTION
GROSS PROFIT
LESS NON PRODUCTION COST
PROFIT/LOSS

14. SUMMARY
• MARGINAL COST IS THE COST MANAGEMENT TECHNIQUE FOR THE ANALYSISOF COST AND REVENUE
INFORMATION AND FOR THE GUIDANCE OF MANAGEMENT. THE PRESENTATIONOF INFORMATION THROUGH
MARGINAL COSTING STATEMENT IS EASILY UNDERSTOOD BY ALL MANGERS,EVEN THOSE WHO DO NOT
HAVE PRELIMINARY KNOWLEDGE AND IMPLICATIONS OF THE SUBJECTS OF COST AND MANAGEMENT
ACCOUNTING.
• ABSORPTION COSTING AND MARGINAL COSTING ARE TWO DIFFERENT TECHNIQUES OF COST
ACCOUNTING. ABSORPTION COSTING IS WIDELY USED FOR COST CONTROL PURPOSE WHEREAS
MARGINAL COSTING IS USED FOR MANAGERIAL DECISION-MAKING AND CONTROL.

15. THANK YOU 