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  Marginal Costing and Absorption Costing

Difference between Marginal Costing and Absorption Costing

We have described so far the meaning and characteristics of marginal costing. It must be obviously understood through now, that marginal costing is a technique of costing that advocates that only variable costs should be taken into account while working out the total cost of production and when valuing the inventory, just variable costs should be taken into the calculation. Fixed costs contain not to be absorbed in the cost of production but have to be charged to the Costing Profit and Loss Account. On the other hand, within absorption costing all indirect costs that are overheads are first apportioned and then absorbed in the production units.

1. Absorption Costing: Costs are categorized as direct and indirect, direct costs are identifiable with a specific product and therefore charged directly. An indirect cost that is overheads are first identified, apportioned to the cost centers and at last absorbed in the product units on some suitable basis.

Marginal Costing: Costs are categorized as fixed and variable. While direct costs are mainly variable, indirect costs, that is overheads may be semi variable. The variable portion in the total overhead cost is identified and so the total variable costs are computed. Only variable costs are charged to the product when the fixed costs are not absorbed in the product units. They are at last debited to the Costing Profit and Loss Account for calculating the final figure of profit or loss.

So the cost of production under marginal costing is only the variable portion of the total costs.

2. Absorption Costing: The year-end inventory of finished goods within absorption costing is valued at total cost, that is fixed and variable.

Marginal Costing: The year-end inventory is valued at variable cost only. Fixed costs are not taken into account when valuing inventory, like they are not absorbed in the product units.

3. Absorption Costing: The fixed overhead absorption might make some problems such as over/under absorption. This occurs due to the overhead absorption rate that is pre determined. Appropriate corrective entries are to be made to rectify the over/under absorption of overheads; or else the cost of production will be distorted.

Marginal Costing: The fixed overheads are charged straight to the Costing Profit and Loss Account and not absorbed in the product units. So there is no question of under/over absorption of overheads.

4. Absorption Costing: because of the inventory valuation that is done at the full cost, the costs relating to the current period are carried forward to the consequent period. This will distort the cost of production.

Marginal Costing: Fixed costs are not taken into consideration when valuing the inventory and therefore there is no distortion of profits.

5. Absorption Costing: The total cost of production is charged to the product with no differentiate among the fixed and variable components. So The selling price is fixed on the basis of total costs.

Marginal Costing: Only variable costs are charged to the cost of production and so the selling price is also based on only variable costs. This will result in fixation of selling price under the total costs. There is a option of starting a price war in such type of situations, that will be harmful to all the companies in the industry.

The points of difference between the absorption costing and marginal costing will make clear the variation among the two.

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