TRADITIONAL COSTING

SYSTEMS
ABSORPTION AND MARGINAL
COSTING

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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

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Definition
 Absorption costing
 Marginal costing

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

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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

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 Absorption Costing
Cost
Manufacturing cost Non-manufacturing cost

Direct Direct Overheads

Materials Labour Period cost

Finished goods Cost of goods sold Profit and loss account

Marginal Costing
Cost
Manufacturing cost Non-manufacturing cost

Direct Direct Variable Fixed

Materials Labour Overheads overhead Period cost

Finished goods Cost of goods sold Profit and loss account

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Presentation of costs on income
statement

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 Trading, Profit or Loss Account

Variable and fixed manufacturing

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Example

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

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Absorption Costing

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Marginal Costing

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16
Back
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 No fixed factory overhead

Back
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Difference between absorption
and marginal costing

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 Absorption costing Marginal costing
Treatment for Fixed Fixed manufacturing
fixed manufacturing overhead are treated
manufacturing overheads are as period costs. It is
overheads treated as product believed that only the
cost. It is believed variable costs are
that products cannot relevant to decision-
be produced without making.
the resources Fixed manufacturing
provided by fixed overheads will be
manufacturing incurred regardless
overheads there is production or
not
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 Absorption costing Marginal costing
Value of High value of Lower value of
closing stock closing stock will be closing stock that
obtained as some included the variable
factory overheads cost only
are included as
product costs and
carried forward as
closing stock

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 Absorption costing Marginal costing
Reported If the production = Sales, AC profit = MC Profit
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

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Argument for absorption costing

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 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

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Arguments for marginal costing

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 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

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 Bibliography
Adeniji, A. (2009). Cost accounting: A managerial approach
Lagos, El-Toda Ventures Limited

http://202.82.16.155/bss/account/notes2/Absorption%20and
%20marginal%20costing.ppt.

http://www.blackhallpublishing.com/webresources/html/Slides/
ma_ch04_slides.ppt.

Cost Accounting by Dr O. J. Akinyomi is licensed under a Creative Commons Attribution-

Non Commercial 4.0 International License
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