Absorption and Marginal costing

Absorption (Full) Vs Marginal (Variable) unit cost

Absorption costing takes all the costs into product cost bar non production overheads so FPO (Fixed Production overheads) are included in unit costs (cost/unit) only period costs are non production overheads

Marginal variable costing doesnt include FPO into unit cost but instead keeps it as a period cost with non production overheads as a total + whole sume of fpo at the end

How to calculate Absorption cost per unit

Direct material + Direct labour + Direct expense + Variable production overhead + fixed production overhead

DIVIDED BY UNITS IF GIVEN AS WHOLE NUMBER

How to calculate variable cost per unit

direct material + direct labour + direct expense + variable production overhead

Absorption costing profit statement

Revenue

(-) COS (open inv+purchases-closing inv)

(-) Non production overhead

Marginal costing profit statement

Revenue

(-) COS (open inv - purchases - closing inv)

Contribution Total

(-)Fixed production overhead

(-)Non production overhead

How does profit differ between the two

if production > sales - money stays tied up in inventory (fpo per unit) in absorption costing compared to marginal costing where all fpo would have been accounted for so a lower net profit

if sales > production - FPO from inventory all gets released increasing COS in absorption costing reducing gross profit whereas in marginal costing all FPO has been accounted for already so would see a higher net profit

advantages of absorption costing

Meets IFRS and IAS standards making it a legal requirement

All costs follow product including fixed ones are attatched to product until its sold

prices are set to cover EVERYTHING (smarter pricing)

cons of absorption costing

products can look unprofitbale if allocated high fixed costs , whereas in relaity it could be contributing - if dropped the fixed costs dont get dropped they just get moved to another product

Overproducing can look better as ixed costs are spread between more units but these could sit in a wharehouse unsold which would hurt the business in reality (to stop introduce penalties and punsihments for managers that d this)

pros of marginal costing

profit reported is closer to actual cash flow generated by the business making it more useful for management decision making

fixed costs are easily identiabe on marginal costing wherehas absoprtio costing includes fixed costs in unit costs could get lost

if inventory levels increase profitability is not affected as much as absoprtion costing

cons of marginal costing

can be unreleastic for business with fluctutating sales like seasonal demand where fixed and variable costs may change

fixed and variable costs are not the only costs giving misleading results - in real life scenarios mixed /stepped costs are very common

not suitable for long term planning as fixed costs will change and this needs to be included in planning