AC114: Chapter 3 - Marginal costing and absorption

contribution

How are fixed production costs treated differently in marginal vs absorption costing?

Absorption — fixed costs absorbed in each unit, included in inventory value until sold

Marginal — fixed costs treated as seperate expense, charged to income statement .

How is inventory valued under each costing method?

Absorption costing → full production cost per unit (FC + VC).

Marginal costing → variable production cost per unit only.

What is contribution and how is it calculated?

What's left from revenue after deducting all variable costs. Contributes to cover FC, leftover is profit.

Contribution = selling price − variable cost per unit

Total contribution formula

Total contribution = Units sold × (selling price − variable cost per unit).

Profit under marginal costing?

Total contribution - Fixed costs

Total contribution = Units sold × (selling price − variable cost per unit).

Absorption costing profit?

Revenue − full production cost of sales ± over/under absorption − non-production costs = Profit.

What is the key difference in the profit templates between the two methods?

Marginal costing shows contribution then deducts all fixed costs.

Absorption costing has no contribution line and includes an over/under absorption adjustment instead.

When will absorption costing report a higher profit than marginal costing?

• Rising inventory (more units are produced than sold) (RIAM)

• Fixed costs are absorbed into each unit

• Unsold units carry some fixed costs into closing inventory, not charged to the period

When will marginal costing report a higher profit than absorption costing?

• Falling inventory (more sold than produced)

• Opening inventory releases fixed costs into the period under absorption costing

• Increasing total costs for absorption costing

Rising, falling and unchanged inventory for AC and MC

• If inventory rises → absorption profit is higher (fixed costs held back by AC)

• If inventory falls → marginal profit is higher (fixed costs released from AC)

• If inventory is unchanged, both profits are equal

What is reconciliation used for?

To explain the difference in profit between absorption and marginal costing, caused by fixed costs moving in and out of inventory.

Absorption costing reconciliation formula

Marginal profit + (change in inventory units × OAR per unit)

Marginal costing reconciliation formula

Marginal profit = Absorption profit − (change in inventory units × OAR per unit)

What are the advantages of absorption costing?

• Fixed costs are shared across all units.

• Compliance with accounting standards.

• Shows whether products are profitable after all costs.

What are the advantages of marginal costing?

• Simpler to operate.

• No over/under absorption.

• More useful for decision-making.

What is the short-cut marginal costing profit calculation?

Contribution = actual units sold × (selling price − all variable costs per unit). Then deduct all fixed costs.

What is the short-cut absorption costing profit calculation?

Revenue − (units sold × full production cost per unit) ± over/under absorption − non-production costs = Profit. Only works when full production cost per unit is unchanged from prior period.

What are the disadvantages of marginal costing?

• Doesn’t comply with accounting standards.

• Ignoring fixed costs in unit costs can mislead product profitability assessments.