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.
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Source: Marginal Costing vs Absorption Costing (wallstreetmojo.com)
- 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 costs. 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. read more and tax reporting.
There’s a debate on which costing method is better – marginal costing or absorption costing.
Marginal Costing vs. Absorption Costing Infographics
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For eg:
Source: Marginal Costing vs Absorption Costing (wallstreetmojo.com)
Key Differences
- Marginal costing doesn’t take fixed costs into account under product costing or inventory valuation. 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 costing 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.
Comparative Table
| 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 costs 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 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; |
Conclusion
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 point, 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.
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