Description
compares absorption costing vs marginal costing. It also explains the profit statements under marginal and absorption costing.
MARGINAL COSTING VS. ABSORPTION COSTING:
A PARCTICAL PERESPECTIVE
Marginal costing is also termed as variable costing, a technique of costing which includes only variable manufacturing costs , in the form of direct materials, direct labour, and variable manufacturing overheads while determining the cost per unit of a product. Where as Absorption costing, is a costing technique that includes all manufacturing costs, in the form of direct materials, direct labour, and both variable and fixed manufacturing overheads, while determining the cost per unit of a product. It is also referred to as the full- cost technique. In the costing of product/service, a marginal costing technique considers the behavioural characteristics of costs (segregations of costs into fixed and variable elements), because per unit variable cost is fixed and total costs are variable in nature, where as total fixed costs are fixed and per unit fixed cost is variable in nature and furthermore variable costs are controllable in nature, while total fixed costs are un-controllable in nature. Marginal costing is useful for short-term planning, control and decision-making, particularly in a business where multi-products are produced. In marginal costing technique, the contribution is calculated after deducting variable costs from sales value with reference to each product or service, in order to calculate the total contribution from all products/services which are made towards the total fixed costs incurred by the business. As the fixed costs are treated as period costs, are deducted from total contribution to arrive at net profit. In the context of costing of a product/service, an absorption costing considers a share of all costs incurred by a business to each of its products/services. In absorption costing technique; costs are classified according to their functions. The gross profit is calculated after deducting production costs from sales and from gross profit, costs incurred in relation to other business functions are deducted to arrive at the net profit. Absorption costing gives better information for pricing products as it includes both variable and fixed costs. Marginal costing may lead to lower prices being offered if the firm is operating below capacity. Customers may still expect these lower prices as demand/capacity increases. Profit Statements under Marginal and Absorption Costing: The net profit shown by marginal costing and absorption costing techniques may not be the same due to the different treatment of fixed manufacturing overheads. Marginal costing technique treats fixed manufacturing overheads as period costs, where as in absorption costing technique these are absorbed into the cost of goods produced and are only charged against profit in the period in which those goods are sold. In absorption costing income statement, adjustment pertaining to under or over-absorption of overheads is also made to arrive at the profit. Terms explained: Product and Period Costs:
Page 1 of 4
1 2
Product costs: the costs of manufacturing the products; Period costs: these are the costs other than product costs that are charged to, debited to, or written off to the income statement each period.
A Case Example on Marginal and Absorption Costing: Data for a Quarter for a manufacturing company:— Level of Activity Sales and Production(Units) Sales Production costs : (Variable and fixed) Sales, distribution and administration costs (Variable and fixed) 60% 36,000 Rs. (’000) 432 366 126 100% 60,000 Rs. (’000) 720 510 150
The normal level of activity for the current year is 60,000 units, and fixed costs are incurred evenly throughout the year. There were no stocks of the product at the start of the quarter, in which 16,500 units were made and 13,500 units were sold. Actual fixed costs were the same as budgeted. Then, various calculations regarding Absorption vs. Marginal costing can be worked out as under:— Production Sales etc Costs (Rs.) costs (Rs.) Total costs of 60,000 units 5,10,000 1,50,000 (fixed plus variable) Total costs of 36,000 units 3,66,000 1,26,000 (fixed plus variable) Difference = variable costs of 24,000 units 1,44,000 24,000 Variable costs per unit Rs.6 Re.1 Production Sales etc. Costs (Rs.) Costs (Rs.) Total costs of 60,000 units 5,10,000 1,50,000 Variable costs of 60,000 units 3,60,000 60,000 Fixed costs 1,50,000 90,000 The rate of absorption of fixed production overheads will therefore be: Rs.1,50,000 ÷ 60,000 = Rs. 2.50 per unit. (i) The fixed production overhead absorbed by the products would be 16,500 units produced × Rs. 2.50 = Rs. 41,250 (ii) Budgeted annual fixed production overhead = Rs.1,50,000 Actual quarterly fixed production overhead = budgeted quarterly fixed production overhead (1,50,000 ÷ 4) Production overhead absorbed into production [see (i) above] Page 2 of 4 Rs. 37,50 0 41,25 0
Over -absorption of fixed production overhead
3,750
Page 3 of 4
(iii) (a)
Profit statement for the quarter, using Absorption Costing Rs. Rs. Rs. Sales (13,500× Rs.12) 1,62,000 Costs of production (no opening stocks) Value of stocks produced (16,500 × Rs. 8.50) 1,40,250 Less value of closing stock (3,000 units × full production cost of Rs. 8.50) (25,500) 1,14,750 Sales etc costs Variable (13,500 × Re. 1) 13,500 Fixed (1/4 of Rs. 90,000) 22,500 36,000 Total cost of sales 1,50,750 Less over-absorbed production overhead 3,750 1,47,000 Profit 15,000
(b)
Profit statement for the quarter using Marginal Costing Rs. Rs. 1,62,000 99,000 18,000 81,000 13,500 94,500 67,500 37,500 22,500 60,000 7,500
Sales (13,500×Rs.12) Variable costs of production (16,500 × Rs. 6) Less value of closing stocks (3,000 × Rs. 6) Variable production cost of sales Variable sales etc. costs (13,500 × Re.1) Total variable cost of sales (13,500 × Rs. 7) Contribution (13,500 × Rs. 5) Fixed Costs: Production Sales etc. Profit
Conclusion: Hence, Profits as shown by Marginal and Absorption Costing techniques are not the same, due to the reasons explained above. Page 4 of 4
doc_612009954.doc
compares absorption costing vs marginal costing. It also explains the profit statements under marginal and absorption costing.
MARGINAL COSTING VS. ABSORPTION COSTING:
A PARCTICAL PERESPECTIVE
Marginal costing is also termed as variable costing, a technique of costing which includes only variable manufacturing costs , in the form of direct materials, direct labour, and variable manufacturing overheads while determining the cost per unit of a product. Where as Absorption costing, is a costing technique that includes all manufacturing costs, in the form of direct materials, direct labour, and both variable and fixed manufacturing overheads, while determining the cost per unit of a product. It is also referred to as the full- cost technique. In the costing of product/service, a marginal costing technique considers the behavioural characteristics of costs (segregations of costs into fixed and variable elements), because per unit variable cost is fixed and total costs are variable in nature, where as total fixed costs are fixed and per unit fixed cost is variable in nature and furthermore variable costs are controllable in nature, while total fixed costs are un-controllable in nature. Marginal costing is useful for short-term planning, control and decision-making, particularly in a business where multi-products are produced. In marginal costing technique, the contribution is calculated after deducting variable costs from sales value with reference to each product or service, in order to calculate the total contribution from all products/services which are made towards the total fixed costs incurred by the business. As the fixed costs are treated as period costs, are deducted from total contribution to arrive at net profit. In the context of costing of a product/service, an absorption costing considers a share of all costs incurred by a business to each of its products/services. In absorption costing technique; costs are classified according to their functions. The gross profit is calculated after deducting production costs from sales and from gross profit, costs incurred in relation to other business functions are deducted to arrive at the net profit. Absorption costing gives better information for pricing products as it includes both variable and fixed costs. Marginal costing may lead to lower prices being offered if the firm is operating below capacity. Customers may still expect these lower prices as demand/capacity increases. Profit Statements under Marginal and Absorption Costing: The net profit shown by marginal costing and absorption costing techniques may not be the same due to the different treatment of fixed manufacturing overheads. Marginal costing technique treats fixed manufacturing overheads as period costs, where as in absorption costing technique these are absorbed into the cost of goods produced and are only charged against profit in the period in which those goods are sold. In absorption costing income statement, adjustment pertaining to under or over-absorption of overheads is also made to arrive at the profit. Terms explained: Product and Period Costs:
Page 1 of 4
1 2
Product costs: the costs of manufacturing the products; Period costs: these are the costs other than product costs that are charged to, debited to, or written off to the income statement each period.
A Case Example on Marginal and Absorption Costing: Data for a Quarter for a manufacturing company:— Level of Activity Sales and Production(Units) Sales Production costs : (Variable and fixed) Sales, distribution and administration costs (Variable and fixed) 60% 36,000 Rs. (’000) 432 366 126 100% 60,000 Rs. (’000) 720 510 150
The normal level of activity for the current year is 60,000 units, and fixed costs are incurred evenly throughout the year. There were no stocks of the product at the start of the quarter, in which 16,500 units were made and 13,500 units were sold. Actual fixed costs were the same as budgeted. Then, various calculations regarding Absorption vs. Marginal costing can be worked out as under:— Production Sales etc Costs (Rs.) costs (Rs.) Total costs of 60,000 units 5,10,000 1,50,000 (fixed plus variable) Total costs of 36,000 units 3,66,000 1,26,000 (fixed plus variable) Difference = variable costs of 24,000 units 1,44,000 24,000 Variable costs per unit Rs.6 Re.1 Production Sales etc. Costs (Rs.) Costs (Rs.) Total costs of 60,000 units 5,10,000 1,50,000 Variable costs of 60,000 units 3,60,000 60,000 Fixed costs 1,50,000 90,000 The rate of absorption of fixed production overheads will therefore be: Rs.1,50,000 ÷ 60,000 = Rs. 2.50 per unit. (i) The fixed production overhead absorbed by the products would be 16,500 units produced × Rs. 2.50 = Rs. 41,250 (ii) Budgeted annual fixed production overhead = Rs.1,50,000 Actual quarterly fixed production overhead = budgeted quarterly fixed production overhead (1,50,000 ÷ 4) Production overhead absorbed into production [see (i) above] Page 2 of 4 Rs. 37,50 0 41,25 0
Over -absorption of fixed production overhead
3,750
Page 3 of 4
(iii) (a)
Profit statement for the quarter, using Absorption Costing Rs. Rs. Rs. Sales (13,500× Rs.12) 1,62,000 Costs of production (no opening stocks) Value of stocks produced (16,500 × Rs. 8.50) 1,40,250 Less value of closing stock (3,000 units × full production cost of Rs. 8.50) (25,500) 1,14,750 Sales etc costs Variable (13,500 × Re. 1) 13,500 Fixed (1/4 of Rs. 90,000) 22,500 36,000 Total cost of sales 1,50,750 Less over-absorbed production overhead 3,750 1,47,000 Profit 15,000
(b)
Profit statement for the quarter using Marginal Costing Rs. Rs. 1,62,000 99,000 18,000 81,000 13,500 94,500 67,500 37,500 22,500 60,000 7,500
Sales (13,500×Rs.12) Variable costs of production (16,500 × Rs. 6) Less value of closing stocks (3,000 × Rs. 6) Variable production cost of sales Variable sales etc. costs (13,500 × Re.1) Total variable cost of sales (13,500 × Rs. 7) Contribution (13,500 × Rs. 5) Fixed Costs: Production Sales etc. Profit
Conclusion: Hence, Profits as shown by Marginal and Absorption Costing techniques are not the same, due to the reasons explained above. Page 4 of 4
doc_612009954.doc