Advantages of marginal costing
(Relative to the absorption costing)
Preparation of routine operating statements using absorption costing is considered less informative for the following reasons:
1. Profit per unit is a misleading figure: in the example above the operating margin of Rs2 per unit arises because fixed overhead per unit is based on output of 5,000 units. If another basis were used margin per unit would differ even though fixed overhead was the same amount in total
2. Build-up or run-down of stocks of finished goods can distort comparison of period operating statements and obscure the effect of increasing or decreasing sales. 3. Comparison between products can be misleading because of the effect of arbitrary apportionment of fixed costs. Where two or more products are manufactured in a factory and share all production facilities, the fixed overhead can only be apportioned on an arbitrary basis. 4. Marginal costing emphasizes variable costs per unit and fixed costs in total whereas absorption costing accounts for all production costs to calculate unit cost. Marginal costing therefore reflects the behavior of costs in relation to activity. Since most decision-making problems involve changes to activity, marginal costing is more appropriate for short-run decision-making than absorption costing.
Advantages of Absorption Costing
(Relative to marginal costing)
Absorption costing is widely used and you must understand both principles. The only difference between using absorption costing and marginal costing as the basis of stock valuation is the treatment of fixed production costs. The arguments used in favor of absorption costing are as follows: 1. Fixed costs are incurred within the production function, and without those facilities production would not be possible. Consequently such costs can be related to production and should be included in stock valuation.
2. Absorption costing follows the matching concept by...
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