Overview
The lecture explains the concepts, calculation methods, and comparative advantages of marginal costing and absorption costing, focusing on their use in cost calculation and profit determination for manufacturing businesses.
Introduction to Marginal and Absorption Costing
- Marginal costing and absorption costing are two key methods for calculating cost per unit in manufacturing.
- Marginal costing includes only variable costs; absorption costing includes both variable and fixed production overheads.
- These topics frequently appear in CMA and ACCA management accounting exams.
Calculation of Cost Per Unit
- Under marginal costing, cost per unit = direct material + direct labor + variable production overhead only.
- Under absorption costing, cost per unit = direct material + direct labor + variable production overhead + fixed production overhead.
- Fixed production overhead per unit is calculated by dividing total fixed overhead by production capacity.
- Absorption costing always results in higher cost per unit due to inclusion of fixed overhead.
Preparation of Profit and Loss Statement
- Both methods start profit calculation with sales (selling price × units sold).
- For marginal costing, variable cost of goods sold is subtracted, considering opening and closing stock.
- Fixed costs are subtracted after contribution margin in marginal costing; all fixed costs are included here.
- In absorption costing, cost of goods sold includes fixed overhead, and fixed overhead is not subtracted separately.
- When production equals sales and there is no opening/closing stock, both methods yield identical profits.
Impact of Closing and Opening Stock
- If production differs from sales, closing stock must be calculated and affects profit.
- Under absorption costing, closing stock is valued higher due to inclusion of fixed overhead.
- Profits will differ between methods when there is opening or closing stock.
Over/Under Absorption of Overhead
- If production is less than capacity, some fixed overhead is under-absorbed (not fully recovered).
- Under-absorbed overhead must be subtracted from profit; calculated as (capacity units – produced units) × fixed overhead per unit.
- If production exceeds capacity, over-absorbed overhead is added to profit.
Practical Applications and Theoretical Points
- Marginal costing is also known as variable or direct costing; it is useful for pricing in competitive, bidding environments.
- Absorption costing is required for external financial reporting as per accounting standards.
- Minimum price for a unit is determined by marginal cost, not absorption cost.
Key Terms & Definitions
- Marginal Costing — A costing method considering only variable costs for product costing and decision-making.
- Absorption Costing — A costing method including both variable and fixed production overheads in product cost.
- Fixed Production Overhead — Costs like factory rent that do not change with output within relevant range.
- Contribution Margin — Sales revenue minus total variable costs.
- Under-absorbed Overhead — Fixed overhead not recovered due to production being less than capacity.
- Over-absorbed Overhead — Excess fixed overhead recovered when production exceeds capacity.
Action Items / Next Steps
- Practice calculations of cost per unit and profit/loss using both methods, including scenarios with different production and sales levels.
- Review exam questions on marginal vs. absorption costing for further practice.