Absorption and Marginal Costing
Absorption and marginal costing
(Relevant to AAT Examination Paper 3: Management Accounting)
Li Tak Ming, Andy
Deputy Head, Department of Business Administration, Hong Kong Institute of
Vocational Education (Kwai Chung)
Introduction
Absorption costing and marginal costing are alternative cost accumulation systems used to ascertain product or job costs for inventory valuation and cost of sales.
Absorption costing
Absorption costing includes both variable and fixed production costs in the cost units.
Under absorption costing, closing inventory and production cost of sales are valued at full production cost. An absorption costing system is required by Hong Kong
Accounting Standard (HKAS) 2 “Inventories” for valuation of inventory when preparing financial statements for external use. Gross profit is obtained when the production cost of sales is deducted from sales.
Marginal costing
Marginal costing is also known as variable costing. It includes variable costs in the cost units and fixed costs are treated as period costs, which are written off in the profit statement of the period to which they relate. Variable costs may include production costs and non-production variable costs.
Under marginal costing, closing inventory (cost units which have not been sold) is valued at variable production cost only. Cost of sales (cost units which have been sold) are valued at variable cost, which may include production and non-production costs.
The contribution is obtained when the variable cost of sales is deducted from sales.
Treatment of overheads under absorption costing and marginal costing
Absorption costing and marginal costing treat overheads differently.
Under absorption costing, closing inventory and production cost of sales are valued at full production cost including a share of the fixed production overheads. When the fixed production overheads incurred differ from the fixed production overheads absorbed, there will be an under or over
(Relevant to AAT Examination Paper 3: Management Accounting)
Li Tak Ming, Andy
Deputy Head, Department of Business Administration, Hong Kong Institute of
Vocational Education (Kwai Chung)
Introduction
Absorption costing and marginal costing are alternative cost accumulation systems used to ascertain product or job costs for inventory valuation and cost of sales.
Absorption costing
Absorption costing includes both variable and fixed production costs in the cost units.
Under absorption costing, closing inventory and production cost of sales are valued at full production cost. An absorption costing system is required by Hong Kong
Accounting Standard (HKAS) 2 “Inventories” for valuation of inventory when preparing financial statements for external use. Gross profit is obtained when the production cost of sales is deducted from sales.
Marginal costing
Marginal costing is also known as variable costing. It includes variable costs in the cost units and fixed costs are treated as period costs, which are written off in the profit statement of the period to which they relate. Variable costs may include production costs and non-production variable costs.
Under marginal costing, closing inventory (cost units which have not been sold) is valued at variable production cost only. Cost of sales (cost units which have been sold) are valued at variable cost, which may include production and non-production costs.
The contribution is obtained when the variable cost of sales is deducted from sales.
Treatment of overheads under absorption costing and marginal costing
Absorption costing and marginal costing treat overheads differently.
Under absorption costing, closing inventory and production cost of sales are valued at full production cost including a share of the fixed production overheads. When the fixed production overheads incurred differ from the fixed production overheads absorbed, there will be an under or over
References: Colin Drury, Management and Cost Accounting, 7th Edition 2008, South-Western Andy Tak-ming Li & Patrick Kin-wai Ho, BAFS in the New World, Accounting – Elective Part 2 Cost Accounting, First Edition 2010, Pilot Publishing Company Ltd. 4