Difference Between Marginal Costing and Absorption Costing
Both the Marginal costing and absorption costing are the two different approaches used for 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.
If you want to understand how the costs of the finished products or inventories are calculated, you would need to give special attention to marginal costing and absorption costing.
- Marginal costing is a method where the variable costs are considered as the product cost, and the fixed costs are considered as the costs of the period.
- Absorption costing, on the other hand, is a method that considers both fixed costs 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.. This costing method is essential, particularly for reporting purposes. Reporting purpose includes both financial reportingFinancial ReportingFinancial Reporting is the process of disclosing all the relevant financial information of a business for a particular accounting period. These reports are used by the stakeholders (investors, creditors/ bankers, public, regulatory agencies, and government) to make investing and other relevant decisions. and tax reporting.
There’s a debate on which costing method is better – marginal costing or absorption costing.
Marginal Costing vs. Absorption Costing Infographics
- Marginal costing doesn’t take fixed costs into account under product costing or inventory valuationInventory Valuation Inventory Valuation Methods refers to the methodology (LIFO, FIFO, or a weighted average) used to value the company's inventories, which has an impact on the cost of goods sold as well as ending inventory, and thus has a financial impact on the company's bottom-line numbers and cash flow situation.. Absorption costing, on the other hand, takes both fixed costs and variable costs into account.
- Marginal costing can be classified as fixed costs and variable costs. Absorption costing can be classified as production, distribution, and selling & administration.
- The purpose of marginal costing is to show forth the contribution of the product cost. The purpose of absorption costingAbsorption CostingAbsorption costing is one of approach which is used for the purpose of valuation of inventory or calculation of the cost of the product in the company where all the expenses incurred by the company are taken into the consideration i.e., it includes all the direct and indirect expenses incurred by the company during the specific period. is to provide a fair and accurate picture of the profits.
- Marginal costing can be expressed as a contribution per unit. Absorption costing can be expressed as net profit per unit.
- Marginal costing is a method of costing, and it isn’t a conventional way of looking at costing methods. Absorption costing, on the other hand, is used for financial and tax reporting, and it is the most convenient method of costing.
|Basis for Comparison||Marginal Costing||Absorption Costing|
|1. Meaning||Marginal costing is a technique that assumes only variable costs as product costs.||Absorption costing is a technique that assumes both fixed costs and variables 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 overheads||Fixed 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. are considered in product costs; that’s why profit reduces.|
|5. Determines||The cost of the next unit;||The cost of each unit.|
|6. Opening & Closing stocks||Since 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.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 aspect||Contribution per unit.||Net profit per unit.|
|8. Purpose||To 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;|
From the discussion above, it is clear that absorption costing is a better method than marginal costing in usefulness. But 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., marginal costing may be useful.
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 its cost-effectively.
This article has been a guide to marginal costing vs. absorption costing. Here we discuss the top differences between marginal and absorption costing along with infographics and comparison table. You may also have a look at the following articles for gaining further knowledge in accounting –