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Difference between marginal costs and absorption costs

Difference between marginal costs and absorption costs

There are two alternative approaches for inventory evaluation; they are marginal costs and absorption costs. In marginal cost, the marginal cost determined by the bifurcation of the fixed and variable costs. Only variable costs are charged to the operation, while fixed costs are excluded from this and are charged to the profit and loss account for the period.

The Conversation, the Absorption cost or otherwise known as total cost, a cost calculation technique in which all costs, fixed or variable, are absorbed by the total units produced. used for reporting purposes, for example for financial and tax reporting. There are many who say that marginal costs are better, while others prefer absorption costs. Hence, one should know the difference between the marginal cost and the absorption cost to be reached at the conclusion, from which to choose between one and the other.

Comparative chart

Basis for comparison Marginal cost Absorption of costs
Sense A decision-making technique to ascertain the total cost of production known as Marginal Costing. The breakdown of the total costs for the cost center in order to determine the total production cost known as the Absorption Cost.
Cost recognition The variable cost considered as the cost of the product while the fixed cost considered as the cost of the period. Both fixed and variable costs are considered as product costs.
General costs classification Solved and variable Production, administration and sale and distribution
pROFITABILITY Profitability measured by the profit ratio. Due to the inclusion of the fixed cost, profitability is affected.
Cost per unit The changes in the opening and closing stock do not affect the cost per production unit. Changes in the opening and closing stock affect the unit cost.
Emphasizes Contribution per unit Net profit per unit
Cost data Presented to outline the total contribution of each product. Conventionally presented.

Definition of the marginal cost

Marginal Costing, also known as Variable Cost, a method of determining costs on the basis of which it is possible to make decisions regarding the assessment of the total cost or the determination of fixed and variable costs to identify the best process and product for production , etc.

Identifies the marginal cost of production and shows its impact on profit for the change of production units. The marginal cost refers to the movement in the total cost, due to the production of an additional output unit.

In the calculation of marginal costs, all variable costs are considered product related costs while fixed costs are considered as period costs. Therefore, fixed production costs are recorded in the profit and loss account. Furthermore, at the time of determining the sale price of the product or at the time of evaluating the final stocks (regardless of whether it is finished products or work in progress), the fixed cost is not considered relevant.

Definition of the absorption cost

The calculation of the absorption cost is a method for the evaluation of the stocks according to which all the production costs are assigned to the cost centers to recognize the total production cost. These production costs include all fixed and variable costs. the traditional method for ascertaining costs, also known as Full Absorption Costing.

In an absorption costing system, both fixed and variable costs are considered product related costs. In this method, the goal of assigning the total cost to the cost center is to recover it from the sale price of the product.

On the basis of the function, the expenses are divided into production, administration and sale and distribution. The following are the types of calculation of the absorption cost:

  • Activity-based cost
  • Job Costing
  • Cost process

Key differences between marginal costs and absorption costs

The main differences between marginal costs and absorption costs are shown below.

  1. The cost calculation method in which the variable cost is distributed exclusively to products known as Marginal Costing. Absorption Cost a system of costs in which all costs are absorbed and divided into products.
  2. In the calculation of the marginal cost, the costs relating to the product will include only the variable cost while, in the case of the calculation of the absorption cost, the fixed cost also included in the cost related to the product, apart from the variable cost.
  3. Marginal costing divides general costs into two general categories, namely fixed overhead and variable overhead. Look at the other term Absorption costs, which classifies overhead costs into the following three categories: Production, Administration and Sales and Distribution.
  4. In marginaling costing profit it can be obtained with the help of the Profit Volume Ratio ((Contribution / Sales) * 100). On the other hand, net profit shows the profit when calculating the absorption cost.
  5. Changes in Marginal Costing in the opening and closing stock will not affect the unit cost. Unlike the absorption cost, where the variations between the stock at the beginning and the end will show its effect by increasing / decreasing by unit cost.
  6. In calculating marginal costs, cost data is presented to outline the total cost of each product. On the contrary, in the calculation of the absorption costs, the cost data are presented in the traditional way, the net profit of each product determined after deducting the fixed cost together with their variable cost.

Conclusion

It is possible to see the differences in profits generated in the income statement by the two-cost system as the absorption cost procedure, the allocations set the production costs to the output while the marginal cost system ignores it. In addition, absorption costs are based on expected production levels, but since fixed costs remain unchanged regardless of production levels, they create variations in actual and budgetary levels at the time of recovery.