Comparing Absorption Costing To Marginal Costing

November 17th, 2007 Comments off
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Marginal Costing Versus Absorption Costing
The MAIN DIFFERENCE is the treatment of FIXED COSTS. This treatment can produce different profit figures.The two methods of costing produce different profit levels dependent upon the net change in the level of stock during the period.This is due to the VALUATION of the net change in stock during the period.In summary: the effects of the net change in stock on profitability is as follows:

Net change in stockNet profit

Nil     Marginal=Absorption

Increase                     Absorption>Marginal

DecreaseMarginal>Absorption
Illustration:
Company A manufacture product X. The selling price per unit is $75.00. This product consumes material costing $10 and 2 hours’ direct labor. Fixed overheads are normally absorbed based on materials usage. 

Further Details:
Direct labor rate per hour $4.00
Fixed overhead per annum $50,000
Planned annual production 5,000
Opening Stock 2,000
Actual Unit Sold 6,500

Question:

Compute an Income Statement For Company A using:
(a)The absorption approach and

(b)The marginal costing approach.

(c)Explain why the two methods produce different results.

 

Solution:

(a)Income Statement Under The Absorption Approach:

Sales $487,500
Opening stock $56,000
Production costs $140,000
Closing stock $14,000
Cost of sales $182,000
Profit $305,500

(b) Income Statement -Marginal Costing Approach

 

Sales $487,500
Opening stock
Production costs $36,000
Closing stock $9,000
Cost of sales $117,000
Total Contribution $370,500
Fixed Cost $50,000
Profit $320,500

 

© Reconciliation between marginal & absorption costing

Profit per absorption costing$305,500

Profit per marginal costing$320.500

Difference in profit$15,000

The difference of $15,000 profit between the two method is a result of the valuation of the net change in stock during the period. The actual amount of the fixed overhead in the net change in stock over the period is $15,000 [1,500 unit x $10 fixed overhead per unit]

Absorption costing net change in stock$42,000

Marginal costingnet change in stock$27,000

Difference in stock value$15,000
Please go to my earlier articles on the advantages and disadvantages of absorption costing and marginal costing.

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