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Key Differences

Know the Differences & Comparisons

Difference Between Marginal Costing and Absorption Costing

marginal costing vs absorption costingThere are two alternative approaches for the valuation of inventory; they are Marginal Costing and Absorption Costing. In marginal costing, marginal cost is determined by bifurcating fixed cost and variable cost. Only variable costs are charged to operation, whereas the fixed cost are excluded from it and are charged to profit and loss account for the period.

Converselty, Absorption costing or otherwise known as full costing, is a costing technique in which all costs, whether fixed or variable are absorbed by the total units produced. It is aminly used for reporting purposes, i.e. for financial and tax reporting. There are many who say marginal costing is better, while others prefer absorption costing. So, one should know the difference between marginal costing and absorption costing to reach at conclusion, as to which one to be preferred over the other.

Content: Marginal Costing Vs Absorption Costing

  1. Comparison Chart
  2. Definition
  3. Key Differences
  4. Conclusion

Comparison Chart

Basis for ComparisonMarginal CostingAbsorption Costing
MeaningA decision making technique for ascertaining the total cost of production is known as Marginal Costing.Apportionment of total costs to the cost center in order to determine the total cost of production is known as Absorption Costing.
Cost RecognitionThe 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.
Classification of OverheadsFixed and VariableProduction, Administration and Selling & Distribution
ProfitabilityProfitability is measured by Profit Volume Ratio.Due to the inclusion of fixed cost, profitability gets affected.
Cost per unitVariances in the opening and closing stock does not influence the cost per unit of output.Variances in the opening and closing stock affects the cost per unit.
HighlightsContribution per unitNet Profit per unit
Cost dataPresented to outline total contribution of each product.Presented in conventional way.

Definition of Marginal Costing

Marginal Costing, also known as Variable Costing, is a costing method whereby decisions can be taken regarding the ascertainment of total cost or the determination of fixed and variable cost to find out the best process and product for production, etc.

It identifies the Marginal Cost of production and shows its impact on profit for the change in the output units. Marginal cost refers to the movement in the total cost, due to the production of an additional unit of output.

In marginal costing, all the variable costs are regarded as product related costs while fixed costs are assumed as period costs. Therefore, fixed cost of production is posted to the Profit & Loss Account. Moreover, fixed cost is also not given relevance while determining the selling price of the product or at the time of valuation of closing stock (whether it is finished goods or Work in  Progress).

Definition of Absorption Costing

Absorption Costing is a method for inventory valuation whereby all the manufacturing expenses are allocated to the cost centres to recognise the total cost of production. These manufacturing expenses include all fixed as well as variable costs. It is the traditional method for cost ascertainment, also known by the name Full Absorption Costing.

In an absorption costing system, both the fixed and variable costs are regarded as product related cost. In this method, the objective of the assignment of the total cost to cost centre is to recover it from the selling price of the product.

On the basis of function, the expenses are divided into Production, Administration and Selling & Distribution. The following are the types of Absorption Costing:

  • Activity Based Costing
  • Job Costing
  • Process Costing

Key Differences Between Marginal Costing and Absorption Costing

The following are the major differences between marginal costing and absorption costing.

  1. The costing method in which variable cost is apportioned exclusively, to the products is known as Marginal Costing. Absorption Costing is a costing system in which all the costs are absorbed and apportioned to products.
  2. In Marginal Costing, Product related costs will include only variable cost while in the case of Absorption costing, fixed cost is also included in product related cost apart from variable cost.
  3. Marginal Costing divides overheads into two broad categories, i.e. Fixed Overheads and Variable Overheads. Look at the other term Absorption costing, which classifies overheads in the following three categories Production, Administration and Selling & Distribution.
  4. In marginal costing profit can be ascertained through the help of Profit Volume Ratio [(Contribution / Sales) * 100]. On the other hand, Net Profit shows the profit in case of Absorption Costing.
  5. In Marginal Costing variances in the opening and closing stock will not influence the per unit cost. Unlike Absorption Costing, where the variances between the stock at the beginning and the end will show its effect by increasing/decreasing per unit cost.
  6. In marginal costing, the cost data is presented to outline total cost of each product. On the contrary, in absorption costing, the cost data is presented in traditional way, net profit of each product is ascertained after deducting fixed cost along with their variable cost.

Conclusion

You can see the differences in the profits generated in the income statement by the two costing system because the absorption costing procedure, apportions fixed cost of production to the output whereas the marginal costing system ignores it. Moreover, the absorption costing is based on budgeted levels of output, but because fixed overheads remain same irrespective of the levels of output, it creates variances in the actual and the budgeted levels at the time of its recovery.

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Comments

  1. tavengwa caroline says

    August 27, 2015 at 10:39 pm

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    Reply
  2. Raj-thafinxt says

    October 6, 2015 at 7:12 am

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  3. melisa says

    November 5, 2015 at 1:22 pm

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  4. hamnid nawaz and ali says

    March 18, 2016 at 7:00 am

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  5. bullinstu says

    July 7, 2016 at 2:46 pm

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  6. Lyimo says

    November 28, 2016 at 2:34 pm

    Thank you very much for information.

    Reply
    • Surbhi S says

      November 28, 2016 at 2:47 pm

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      Reply
  7. Linda says

    December 6, 2016 at 10:01 am

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    Reply
  8. maja says

    January 7, 2017 at 4:33 pm

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  9. joan Udoh says

    February 25, 2017 at 7:58 am

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    • Surbhi S says

      June 15, 2017 at 9:44 am

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      Reply
  11. CaptianJackMason says

    January 15, 2018 at 9:29 pm

    Very good information

    Reply
  12. Dushyant says

    July 20, 2018 at 6:34 pm

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    Reply

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