There are two alternative approaches for the valuation of inventory; they are Marginal Costing and Absorption Costing. In marginal costing, marginal cost is determined by bifurcating fixed cost and variable cost. Only variable costs are charged to operation, whereas the fixed cost are excluded from it and are charged to profit and loss account for the period.
Converselty, Absorption costing or otherwise known as full costing, is a costing technique in which all costs, whether fixed or variable are absorbed by the total units produced. It is aminly used for reporting purposes, i.e. for financial and tax reporting. There are many who say marginal costing is better, while others prefer absorption costing. So, one should know the difference between marginal costing and absorption costing to reach at conclusion, as to which one to be preferred over the other.
Marginal Costing, also known as Variable Costing, is a costing method whereby decisions can be taken regarding the ascertainment of total cost or the determination of fixed and variable cost to find out the best process and product for production, etc.
It identifies the Marginal Cost of production and shows its impact on profit for the change in the output units. Marginal cost refers to the movement in the total cost, due to the production of an additional unit of output.
In marginal costing, all the variable costs are regarded as product related costs while fixed costs are assumed as period costs. Therefore, fixed cost of production is posted to the Profit & Loss Account. Moreover, fixed cost is also not given relevance while determining the selling price of the product or at the time of valuation of closing stock (whether it is finished goods or Work in Progress ).
Absorption Costing is a method for inventory valuation whereby all the manufacturing expenses are allocated to the cost centres to recognise the total cost of production. These manufacturing expenses include all fixed as well as variable costs. It is the traditional method for cost ascertainment, also known by the name Full Absorption Costing.
In an absorption costing system, both the fixed and variable costs are regarded as product related cost. In this method, the objective of the assignment of the total cost to cost centre is to recover it from the selling price of the product.
On the basis of function, the expenses are divided into Production, Administration and Selling & Distribution. The following are the types of Absorption Costing:
- Activity Based Costing
- Job Costing
- Process Costing
|Meaning||A decision making technique for ascertaining the total cost of production is known as Marginal Costing.||Apportionment of total costs to the cost center in order to determine the total cost of production is known as Absorption Costing.|
|Cost Recognition||The variable cost is considered as product cost while fixed cost is considered as period costs.||Both fixed and variable cost is considered as product cost.|
|Classification of Overheads||Fixed and Variable||Production, Administration and Selling & Distribution|
|Profitability||Profitability is measured by Profit Volume Ratio.||Due to the inclusion of fixed cost, profitability gets affected.|
|Cost per unit||Variances in the opening and closing stock does not influence the cost per unit of output.||Variances in the opening and closing stock affects the cost per unit.|
|Highlights||Contribution per unit||Net Profit per unit|
|Cost data||Presented to outline total contribution of each product.||Presented in conventional way.|