Management Accounting Notes 2.5 pdf PDF

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Marginal and absorption costing...

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Marginal and Absorption Costing:

Marginal (variable) costing and absorption (full) costing vary in how they treat the fixed costs. - In marginal costing (variable costing), only variable costs of production are allocated to products and the unsold stock is measured at variable cost of production. Fixed production costs are treated as a cost of the period in which they are incurred. - In absorption costing (full costing), all production costs are absorbed into products and the unsold stock is measured at total cost of production.

- A consequence of this is that inventory is valued differently: • under marginal costing it is valued at variable cost of production • under absorption costing, it is valued at variable and fixed (“full”) cost of production

Marginal Costing: Ø only variable costs of production are allocated to products Ø Fixed production overheads (fixed manufacturing overheads) are treated as a period cost Ø In other words, fixed production overheads are not shared amongst the units of output Ø Fixed production overhead costs do not vary with changes of output; therefore, they are not relevant when making decisions about the quantities of output that are produced >> not relevant to internal decision-making process?

Absorption Costing: Ø Absorption costing requires that the unit of product absorbs all production costs, including fixed production overhead costs. Ø As we will discuss this next week, overhead costs are absorbed into products via either a blanket (plant-wide) fixed production overhead absorption rate or multiple departmental rates. Ø This approach may help in setting prices so that the price covers full costs and is required for external reporting purposes (when preparing the statement of profit or loss for external users) Ø However, some people argue that fixed factory overheads will happen anyway. They are caused more by time than by production volume and, hence, must not be allocated to products. Ø In other words, they argue that marginal costing is better for decision making purposes.

Marginal Costing

Used for internal planning and decision making Does not include fixed production overheads as a product cost Gives attention to the concept of contribution

Absorption Costing Used for external financial reporting Includes direct materials, direct labour, variable factory overhead and fixed production overheads as part of total product cost...