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Marginal Costing vs Absorption Costing

Updated on April 11, 2024
Article bySayantan Mukhopadhyay
Edited bySayantan Mukhopadhyay
Reviewed byDheeraj Vaidya, CFA, FRM

Difference Between Marginal Costing and Absorption Costing

Both the Marginal costing and absorption costing are the two different approaches used for the valuation of inventory where in case of Marginal costing only variable cost incurred by the company is applied to the inventory whereas in case of the absorption costing both variable costs and fixed costs incurred by the company are applied to the inventory.

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To understand how the costs of the finished products or inventories are calculated, one would need to give special attention to marginal costing and absorption costing.

Marginal Costing vs. Absorption Costing Infographics

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Video Explanation of Marginal Costing vs Absorption Costing

 

Marginal Costing vs Absorption Costing – Definition

Marginal costing is a method where the variable costs are considered the product cost, and the fixed costs are considered the period’s costs.

On the other hand, absorption costing is a method that considers both fixed and variable costs as product costsProduct CostsProduct cost refers to all those costs which are incurred by the company in order to create the product of the company or deliver the services to the customers and the same is shown in the financial statement of the company for the period in which they become the part of the cost of the goods that are sold by the company.read more. This costing method is essential, particularly for reporting purposes. Reporting purposes include both financial reportingFinancial ReportingFinancial reporting is a systematic process of recording and representing a company’s financial data. The reports reflect a firm’s financial health and performance in a given period. Management, investors, shareholders, financiers, government, and regulatory agencies rely on financial reports for decision-making.read more and tax reporting.

Though aabsorption costing is considered a better method than marginal costing in terms of its usefulness, marginal costing is also useful if a company has just started and the purpose is to see the contribution per unit and the break-even pointBreak-even PointBreak-even analysis refers to the identifying of the point where the revenue of the company starts exceeding its total cost i.e., the point when the project or company under consideration will start generating the profits by the way of studying the relationship between the revenue of the company, its fixed cost, and the variable cost.read more.

Otherwise, it is better to use absorption costing. It will help a firm look at its cost comprehensively. It will be able to strategize around cost-effectively.

However, there is always a debate on which costing method is better – marginal or absorption costing.

Marginal Costing vs Absorption Costing – Key Differences

Some of the major differences between the two have been listed below:

Marginal Costing vs Absorption Costing – Comparative Table

Here is a list of differences between marginal costing and absorption costing in the tabular format:

Basis for ComparisonMarginal CostingAbsorption Costing
1. MeaningMarginal costing is a technique that assumes only variable costs as product costs.Absorption costing is a technique that assumes both fixed costs and variable costs as product costs.
2. What it’s all about?Variable cost is considered as product cost, and fixed cost is assumed as a cost for the period.Both fixed cost and variable costs are considered in product cost.
3. Nature of overheadsFixed costs and variable costs;Overheads, in the case of absorption costing, are quite different – production, distribution, and selling & administration.
4. How is the profit calculated?By using the profit volume ratio (P/V ratio)Fixed costsFixed CostsFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity.read more are considered in product costs; that’s why profit reduces.
5. DeterminesThe cost of the next unit;The cost of each unit.
6. Opening & Closing stocksSince the emphasis is on the next unit, change in opening/closing stocks Closing Stocks Closing stock or inventory is the amount that a company still has on its hand at the end of a financial period. It may include products getting processed or are produced but not sold. Raw materials, work in progress, and final goods are all included on a broad level.read more doesn’t affect the cost per unit.Since the emphasis is on each unit, change in opening/closing stocks affects the cost per unit.
7. Most important aspectContribution per unit.Net profit per unit.
8. PurposeTo show forth the emphasis of contribution to the product cost.To show forth the accuracy and fair treatment of product cost.
9. How is it presented?By outlining the total contribution;Most conveniently for financial and tax reporting;

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