Answer to Question #144891 in Management for Ka

Question

Marginal Costing is a key tool used by Managements for Cost-Volume- Profit analysis enabling comparative assessment of 2 or more products / divisions. However, Absorption costing is the preferred method of accountants as it is a recognized and accepted practice for external reporting.
Please describe the differences between Marginal Costing and Absorption costing
(Any 5).

Answer 1

1. Meaning

Marginal costing is the cost management of technique which is used in determining the total cost of a given production. Whereas absorption costing is the technique that allocates the total costs incurred to various cost centers to separately determine the cost of production in relation to each cost center.

2. Cost Treatment

In marginal costing, it usually deals with first identifying and separating costs according to their identity either fixed or variable. Where variable costs are always allocated to the product as product cost and fixed costs are regarded as period costs and are subtracted directly from the total contribution in order to get the operating profits. Contrary to that absorption costing take into consideration of both fixed and variable costs as product costs and make allocations to the products.

3. Profitability Measurement

Marginal costing identifies variable and fixed costs separately; variable costs are allocated to the product as product cost and fixed costs are considered as period costs and deducted directly from the contribution to arrive at operating profits. Absorption costing considers both fixed and variable costs as product costs and make allocations to the products.

4. Effect on Change in Stock

In marginal costing, the cost of a single unit of stock doesn’t get affected by the varying in the level of both opening and closing stock. Whereas in absorption costing, the difference in opening and closing stocks affects the cost of each unit due to the effect of fixed costs.

5. Cost per Unit

In marginal costing the cost of a single unit remains the same however much the change in the level of production because it's only variable costs which are included in the product cost. On the other hand, in absorption costing, the cost of a single unit is inversely proportional to the level of production as a result of the absorption of fixed costs. However, only the fixed cost reduces per unit and variable costs remain the same.