Question 4 (d)

Absorption costing and marginal costing distinguished

6 marks

Time to write: About 12 minutes
Topic: Absorption and marginal costing

Question

Question 4 (d) · 6 marks

Distinguish between Marginal Costing and Absorption Costing?

Reworded from the university paper; the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.

Before you write

Read off the question and its marks

12 minfor 6 marks

Read from the question

Distinguish betweenSet the differences out in a table, basis by basis, not as two separate essays.

Write it in this order

Read; underline the asks; jot your points 1 min
1 Meaning of each method 2 marks 2 min
2 Differences 4 marks 8 min
Check: every ask answered, key terms underlined 1 min

Easy marks

Meaning of each method (step 1, 2 marks): a clear definition and a line on what it covers. It opens the answer, so it takes a minute or two.

Short on time? Cut step 2 short rather than leave anything out.

Try it first. About 12 minutes for 6 marks. Write it out, then open the solution.

Solution

Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.

Absorption costing

Absorption (full) costing charges all manufacturing costs, direct materials, direct labour, variable overheads and a share of fixed manufacturing overheads, to products. Fixed overheads are absorbed at a predetermined rate, so stocks are valued at full production cost, and any under- or over-absorption is adjusted in the profit and loss account.

Marginal costing

Marginal (variable) costing charges only variable costs to products. Fixed costs are treated as period costs and written off in full against the contribution of the period in which they arise. Stocks are valued at variable cost, and profit is shown as contribution less fixed costs.

Differences

Basis	Absorption costing	Marginal costing
Costs charged to products	All manufacturing costs, fixed and variable	Variable costs only
Fixed manufacturing overheads	Absorbed into product cost	Charged in full to the period
Stock valuation	At full production cost	At variable cost
Profit when stocks rise	Higher, because part of fixed cost is carried forward in stock	Lower
Profit when stocks fall	Lower	Higher
Key measure	Gross profit	Contribution
Under/over-absorption	Arises and must be adjusted	Does not arise
Usefulness for decisions	Less useful for short-term decisions	Very useful: CVP, make or buy, pricing, product mix
External reporting	Required for stock valuation: AS 2 includes a systematic share of fixed production overheads in the cost of inventories	Used mainly for internal reporting

Illustration: suppose 10,000 units are produced, 8,000 are sold at ₹50, variable cost is ₹30 a unit and fixed manufacturing overhead is ₹1,00,000 (₹10 a unit). Marginal costing values the 2,000 units of closing stock at ₹30 and shows profit of ₹1,60,000 − ₹1,00,000 = ₹60,000. Absorption costing values the stock at ₹40, carrying ₹20,000 of fixed overhead forward, and shows ₹80,000.

When production equals sales, both methods give the same profit; the difference in any period equals the fixed overhead in the change in stock.

Where the 6 marks sit

#	Component	Marks
1	Meaning of each method	2
2	Differences	4
	Total	6

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