Costing System

Marginal Costing

Cost of one unit which would be avoided if unit was not produced

Contribution

Contribution = sales revenue less all variable costs

Absorption Costing

Building up a full product cost which adds direct costs and a proportion of overheads

Absorption Costing

• Costs are split based on function

• Inventory is valued at the full production costs

• Sales - cost of sales = gross profit

• Non production overheads are deducted after gross profit

Marginal Costing

• Costs are split based on behaviour

• Inventory is valued at variable production cost

• Sales - all variable cost = contribution

• Variable non production overheads are excluded from the valuation of inventory but deducted before contribution

Impact on Profit

• If inventory is increasing then absorption Costing will give a higher profit

• If inventory is decreasing absorption costing will give a lower profit

• If inventory is constant profit values will be the same

Reconciliation of profits

Absorption costing profit

Less change in inventory x OAR = marginal costing profit

Cost of sales

Opening inventory + production - closing inventory

Advantages of marginal costing

• Marginal costing avoids the need to allocate and absorb fixed overheads

• Fixed costs relate to time so are charged as period costs

• Profit figures are more consistent with fluctuating sales

• Used for short term decision making

Advantages of absorption costing

• Costing technique adheres to the accounting standard for the valuation of IAS 2 so can be used for statutory financial reporting

• The total production cost are considered

• Analysis is useful for controlling costs

Specific order costing

Used when work done by an organisation consists of desperately identifiable jobs or batches

Continuous operation costs

Used when goods or services are produced as a direct result of operations or processes

Service costing

• Intangibility

• Heterogeneity

• Simultaneous production and consumption

• Perishability

Cost per service unit

Cost per service unit = total costs for providing service/number of service units used to provide the service