Absorption costing is a costing technique in which all the costs associated with the production of a good or service are accounted for. It is used by companies to create a complete picture if their financial situation. It takes into account both variable and fixed costs. The advantages of a company using absorption costing is that it recognizes the importance of fixed costs in production this ensures that all costs are accounted for. When production remains constant but sales fluctuated absorption costing will show less fluctuation in net profit. Absorption costing is the preferred method to prepare financial accounts. Absorption costing does not underestimate the importance of fixed costs. It also avoids small losses being reported, fixed overheads will be deferred and included in the closing inventory valuation and will be recorded as an expense only in the period in which the goods are sold. Loses are therefore unlikely to be reported in the periods when stocks are being built up. Although this can be seen as disadvantage as it hides loses.
However there are disadvantages of absorption costing for example as it emphasized on total costs namely both variable and fixed it is not so useful for management to use to make decisions, planning and control. Also as the manager’s emphasis is on total cost the cost volume profit relationship is ignored. The manager needs to use his intuition to make decision.
Marginal costing is the accounting system in which variable cots are charged to cost units and the fixed costs of the period are written off in full against the aggregate contribution. The marginal costing technique makes a sharp distinction between variable costs and fixed costs. It is the variable cost on the basis of which production and sales policies are designed by a firm following the marginal costing technique. Under marginal costing inventory stock for profit measurement is valued at marginal cost. It is in...
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