1. ABSORPTION AND MARGINAL COSTING
Course Lecturer:
Dr. O.J. Akinyomi
Absorption and Marginal Costing by Dr. Oladele John AKINYOMI is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License.

2. Introduction
Previously, we allocate all manufacturing costs to products regardless of whether they are fixed or variable. This approach is known as absorption costing/full costing
However, only variable costs are relevant to decision-making. This is known as marginal costing/variable costing

3. Definition
Absorption costing
Marginal costing

4. Absorption costing
It is costing system which treats all manufacturing costs including both the fixed and variable costs as product costs

5. Marginal costing
It is a costing system which treats only the variable manufacturing costs as product costs. The fixed manufacturing overheads are regarded as period cost

6. Absorption Costing
Cost
Manufacturing cost
Non-manufacturing cost
Direct
Materials
Direct
Labour
Overheads
Period cost
Finished goods
Cost of goods sold
Profit and loss account
Marginal Costing
Cost
Manufacturing cost
Non-manufacturing cost
Direct
Materials
Direct
Labour
Variable
Overheads
Fixed
overhead
Period cost
Finished goods
Cost of goods sold
Profit and loss account

7. Presentation of costs on income statement

8. Trading, Profit or Loss Account
Absorption costing Marginal costing
N N
Sales X Sales X
Less: Cost of goods sold X Less: Variable cost of
Goods sold X
Gross profit X Product contribution margin X
Less: Expenses Less: variable non- manufacturing
Selling expenses X expenses
Admin. expenses X Variable selling expenses X
Other expenses X X Variable admin. expenses X
Other variable expenses X
Total contribution expenses X
Less: Expenses
Fixed selling expenses X
Fixed admin. expenses X
Other fixed expenses X
Net Profit X Net Profit X
Variable and fixed manufacturing

9. Example

10. A company started its business in 2015. The following information
was available for January to March 2015 for the company that produced
A single product: N
Selling price per unit
Direct materials per unit
Direct Labour per unit
Fixed factory overhead per month 30,000
Variable factory overhead per unit 5
Fixed selling overheads 1,000
Variable selling overheads per unit 4
Budgeted activity was expected to be 1,000 units each month
Production and sales for each month were as follows:
Jan Feb March
Unit sold 1, ,100
Unit produced 1,000 1,

11. Required:
Prepare absorption and marginal costing statements for the three months

12. Absorption Costing

13. January February March
N N N
Sales
Less: cost of good sold (N 65)
Adjustment for Over-/(under)
absorption of factory overhead (3000)
Gross profit
Less: Expenses
Fixed selling overheads
Variable selling overheads
Net profit

14. Marginal Costing

15. January February March
N N N
Sales
Less: Variable cost of good
sold (N35)
Product contribution margin
Less: Variable selling overhead
Total contribution margin
Less: Fixed Expenses
Fixed factory overhead
Fixed selling overheads
Net profit

16. Wk1:
Standard fixed overhead rate
= Budgeted total fixed factory overheads
Budgeted number of units produced
= N30000
1000 units
= N30 units
Wk 2:
Production cost per unit under absorption costing: N
Direct materials
Direct labour
Fixed factory overhead absorbed 30
Variable factory overheads 5 65
Back

17. Wk 3:
(Under-)/Over-absorption of fixed factory overheads:
January February March
N N N
Fixed overhead
Fixed overheads incurred
(3000)
1000*N30
1300*N30
900*N30
No fixed factory overhead
Wk 4:
Variable production cost per unit under marginal costing: N
Direct materials
Direct labour
Variable factory overhead 5 35
Back

18. Difference between absorption and marginal costing

19. Absorption costing
Marginal costing
Treatment for fixed manufacturing overheads
Fixed manufacturing overheads are treated as product cost. It is believed that products cannot be produced without the resources provided by fixed manufacturing overheads
Fixed manufacturing overhead are treated as period costs. It is believed that only the variable costs are relevant to decision-making.
Fixed manufacturing overheads will be incurred regardless there is production or not

20. Absorption costing
Marginal costing
Value of closing stock
High value of closing stock will be obtained as some factory overheads are included as product costs and carried forward as closing stock
Lower value of closing stock that included the variable cost only

21. Absorption costing
Marginal costing
Reported profit
If the production = Sales, AC profit = MC Profit
If Production > Sales, AC profit > MC profit
As some factory overhead will be deferred as product costs under the absorption costing
If Production < Sales, AC profit < MC profit
As the previously deferred factory overhead will be released and charged as cost of goods sold

22. Argument for absorption costing

23. Compliance with the generally accepted accounting principles
Importance of fixed overheads for production
Avoidance of fictitious profit or loss
During the period of high sales, the production is small than the sales, a smaller number of fixed manufacturing overheads are charged and a higher net profit will be obtained under marginal costing
Absorption costing is better in avoiding the fluctuation of profit being reported in marginal costing

24. Arguments for marginal costing

25. More relevance to decision-making Avoidance of profit manipulation
Marginal costing can avoid profit manipulation by adjusting the stock level
Consideration given to fixed cost
In fact, marginal costing does not ignore fixed costs in setting the selling price. On the contrary, it provides useful information for break-even analysis that indicates whether fixed costs can be converted with the change in sales volume

26. Bibliography
Adeniji, A. (2009). Cost accounting: A managerial approach
Lagos, El-Toda Ventures Limited
Absorption and Marginal Costing by Dr. Oladele John AKINYOMI is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License.