Department OF Accounting
ACC322 – Advanced Cost Accounting
Omega 2019/2020
MARGINAL COSTING AND
ABSORPTION COSTING
LECTURE OBJECTIVES
At the end of this lecture, students should be able to:
Explain Marginal cost and Marginal costing;
Distinguish between the Marginal costing and
Absorption costing techniques;
Reconcile Marginal costing and Absorption costing
profits.
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INTRODUCTION
• The marginal cost of an item is its variable cost.
The marginal production cost of an item is the
sum of its
• direct materials cost,
• direct labor cost,
• direct expenses cost (if any) and
• variable production overhead cost.
• So as the volume of production and sales
increases total variable costs rise
proportionately.
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• Fixed costs, in contrast are cost that remain unchanged in
a time period, regardless of the volume of production and
sale.
• Marginal production cost is the part of the cost of one
unit of production service which would be avoided if that
unit were not produced, or which would increase if one
extra unit were produced.
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MARGINAL COST
•Marginal cost from the economist view point,
represents the amount by which at any given
volume of output, aggregate costs are changed if
the volume of output is increased or decreased by
one unit.
• It is the change in the total cost when the quantity
produced is incremented by one. That is, it is the
cost of producing one more unit of a good.
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MARGINAL COST
• Variable cost per unit = N 25
• Fixed cost = N 100,000
• Variable Cost of 10,000 units = 25 × 10,000 = N 250,000
• Total Cost of 10,000 units = Fixed Cost + Variable Cost
• = 1,00,000 + 2,50,000 = N 3,50,000
• Total cost of 10,001 units = 1,00,000 + 2,50,025
• = N 3,50,025
• Marginal Cost = 3,50,025 – 3,50,000
• = N 25
• In this case the marginal cost of increasing output by
one unit from 10,000 t0 10,001 is N25. 6
Marginal costing
• Marginal costing is the accounting system in which
variable costs are charged to cost units and fixed costs of
the period are written off in full against the
aggregate contribution.
• Note that variable costs are those which change as
output changes - these are treated under marginal
costing as costs of the product. Fixed costs, in this
system, are treated as costs of the period.
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• Marginal costing is also the
principal costing technique used in decision making.
The key reason for this is that the marginal
costing approach allows management's attention to be
focused on the changes which result from the decision
under consideration.
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Why marginal costing Technique?
• Variable cost per unit remains constant; any increase
or decrease in production changes the total cost of
output.
• Total fixed cost remains unchanged up to a certain
level of production and does not vary with increase
or decrease in production. It means the fixed cost
remains constant in terms of total cost. 9
why
• Fixed expenses exclude from the total cost
in marginal costing technique and provide
us the same cost per unit up to a certain
level of production.
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Features of marginal costing
• Marginal costing is used to know the impact of
variable cost on the volume of production or output.
• Break-even analysis is an integral and important part
of marginal costing.
• Contribution of each product or department is a
foundation to know the profitability of the product
or department.
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• Addition of variable cost and profit to
contribution is equal to selling price.
• Marginal costing is the base of valuation of stock
of finished product and work in progress.
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• Fixed cost is recovered from contribution and
variable cost is charged to production.
• Costs are classified on the basis of fixed and
variable costs only. Semi-fixed prices are also
converted either as fixed cost or as variable cost.
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contribution
• The contribution concept lies at the heart of marginal
costing.
• Contribution can be calculated as follows.
• Contribution = Sales price - Variable costs
•
• The idea of profit is not a particularly useful one as it
depends on how many units are sold. For this reason,
the contribution concept is frequently employed by
management accountants.
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• Contribution gives an idea of how much 'money' there is
available to 'contribute' towards paying for the overheads of
the organization.
• At varying levels of output and sales, contribution per unit is
constant.
• At varying levels of output and sales, profit per unit varies.
• Total contribution = Contribution per unit x Sales volume.
• Profit = Total contribution - Fixed overheads
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Absorption costing
• Absorption costing is a method of building up a full
product cost which adds direct costs and a proportion of
production overhead costs by means of one or a number
of overhead absorption rates.
• Marginal and absorption costing are two different
approaches to dealing with fixed production overheads
and whether or not they are included in valuing inventory
.
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Absorption costing
• It is a method of inventory costing in which all variable
production cost and all fixed production costs are
included in inventoriable costs; that is, inventory absorbs
all production costs. Job costing is an example of
absorption costing.
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Absorption vs Marginal costing
• Absorption costing is a costing system which treats all manufacturing
costs including both the fixed and variable costs as product costs
• While Marginal Costing is a costing system which treats only the variable
manufacturing costs as product costs. The fixed manufacturing
overheads are regarded as period cost
• The main difference between marginal and absorption costing is the
accounting for fixed production costs.
• Under marginal costing, fixed manufacturing costs are not inventoried
but treated as an expense for the period.
• With Absorption costing, fixed manufacturing costs are inventoriable
cost.
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Presentation of Cost Data under Marginal Costing and Absorption
Costing
• Marginal costing is not a method of costing but a technique
of presentation of sales and cost data with a view to guide
management in decision-making.
• The traditional technique popularly known as total cost or
absorption costing technique does not make any difference
between variable and fixed cost in the calculation of profits.
But marginal cost statement very clearly indicates this
difference in arriving at the net operational results of a firm.
• Following presentation of two formats shows the difference
between the presentation of information according to
absorption and marginal costing techniques:
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Marginal costing format N N
Sales Revenue xxxxx
Less Marginal Cost of Sales
Opening Stock (Valued @ marginal cost) xxxx
Add Production Cost (Valued @ marginal cost) xxxx
Total Production Cost xxxx
Less Closing Stock (Valued @ marginal cost) (xxx)
Marginal Cost of Production xxxx
Add Selling, Admin & Distribution Cost xxxx
Marginal Cost of Sales (xxxx)
Contribution xxxxx
Less Fixed Cost (xxxx)
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Marginal Costing Profit xxxxx0
Absorption costing format N N
Sales Revenue xxxxx
Less Absorption Cost of Sales
Opening Stock (Valued @ absorption cost) xxxx
Add Production Cost (Valued @ absorption cost) xxxx
Total Production Cost xxxx
Less Closing Stock (Valued @ absorption cost) (xxx)
Absorption Cost of Production xxxx
Add Selling, Admin & Distribution Cost xxxx
Absorption Cost of Sales (xxxx)
Un-Adjusted Profit xxxxx
Fixed Production O/H absorbed xxxx
Fixed Production O/H incurred (xxxx)
(Under)/Over Absorption xxxxx
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Adjusted Profit xxxxx 1
Reconciliation Statement for Marginal Costing and Absorption
Costing Profit
Marginal Costing Profit xx
ADD (Closing stock – opening Stock) x OAR xx
Absorption Costing profit xx
Where OAR( overhead absorption rate) =
Budgeted fixed production overhead
Budgeted levels of activities
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Differences between absorption and marginal costing
Absorption costing Marginal costing
1. Treatment for Fixed manufacturing Fixed manufacturing
fixed overheads are treated as overhead are treated
product costing. as period costs.
manufacturing
overheads
2. Value of High value of closing Lower value of
closing stock stock will be obtained closing stock that
as some factory included the variable
overheads are included cost only
as product costs and
carried forward as
closing stock 23
A &M
Absorption costing Marginal costing
3. Reported Absorption Costing profit Marginal Costing
profit: = Marginal Costing Profit profit = Absorption
(a) If production Costing Profit
= Sales
(b) If Production Absorption Costing profit Marginal Costing
> Sales > Marginal Costing profit profit < Absorption
Costing profit
(c) If Production Absorption Costing profit Marginal Costing
< Sales < Marginal Costing profit profit > Absorption
Costing profit
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Illustration
• A company started its business in 2005. The following
information
• Was available for January to March 2005 for the
company that produced
• A single product:
• N
• Selling price pre unit 100
• Direct materials per unit 20
• Direct Labour per unit 10
• Fixed factory overhead per month 30,000
• Variable factory overhead per unit 5
• Fixed selling overheads 1000
• Variable selling overheads per unit 4 2
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Illustration cont’d
• Budgeted activity was expected to be 1000 units each month
• Production and sales for each month were as follows:
• Jan Feb March
• Unit sold 1000 800 1100
• Unit produced 1000 1300 900
• Required:
• Prepare absorption and marginal costing statements for the
three months
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solution
•s
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ABSORPTION COSTING
• January February March
• N N N
• Sales 100000 80000 110000
• Less: cost of good sold (N65) 65000 52000 71500
• 28000 38500
• Adjustment for Over-/(under)
• Absorption of factory overhead 9000 (3000)
• Gross profit 35000 37000 35500
• Less: Expenses
• Fixed selling overheads1000 1000 1000
• Variable selling overheads 4000 3200 4400
• Net profit 30000 32800 30100
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Marginal costing
• January February March
• N N N
• Sales 100000 80000 110000
• Less: Variable cost of good
• sold (N35) 35000 28000 385500
• Product contribution margin 65000 52000 71500
• Less: Variable selling overhead4000 3200 4400
• Total contribution margin 61000 48800 67100
• Less: Fixed Expenses
• Fixed factory overhead 30000 30000 30000
• Fixed selling overheads1000 1000 1000
• Net profit 30000 32800 30100
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WORKINGS
• Wk1:
• Standard fixed overhead rate
• = Budgeted total fixed factory overheads
• Budgeted number of units produced
• = N30000
• 1000 units
• = N30 units
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• Wk 2:
• Production cost per unit under absorption costing:
• N
• Direct materials 20
• Direct labour 10
• Fixed factory overhead absorbed 30
• Variable factory overheads 5
• 65
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• Wk 3:
• (Under-)/Over-absorption of fixed factory overheads:
• January February March
• N N N
• Fixed overhead (1000 x N30) 30000 (1300 x N30)39000 (900 x N30) 27000
• Fixed overheads incurred 30000 30000 30000
• 0 9000 (3000)
•
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• Wk 4:
• Variable production cost per unit under marginal costing:
• N
• Direct materials 20
• Direct labour 10
• Variable factory overhead 5
• 35
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Thank you
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