Marginal Costing vs Absorption Costing

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Difference Between Marginal Costing and Absorption Costing

Both the Marginal costing and absorption costing are the two different approaches used for the valuation of inventory where in case of Marginal costing only variable cost incurred by the company is applied to the inventory whereas in case of the absorption costing both variable costs and fixed costs incurred by the company are applied to the inventory.

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To understand how the costs of the finished products or inventories are calculated, one would need to give special attention to marginal costing and absorption costing.

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Marginal Costing vs. Absorption Costing Infographics

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Video Explanation of Marginal Costing vs Absorption Costing

 

Marginal Costing vs Absorption Costing – Definition

Marginal costing is a method where the variable costs are considered the product cost, and the fixed costs are considered the period's costs.

On the other hand, absorption costing is a method that considers both fixed and variable costs as product costs. This costing method is essential, particularly for reporting purposes. Reporting purposes include both financial reporting and tax reporting.

Though aabsorption costing is considered a better method than marginal costing in terms of its usefulness, marginal costing is also useful if a company has just started and the purpose is to see the contribution per unit and the break-even point.

Otherwise, it is better to use absorption costing. It will help a firm look at its cost comprehensively. It will be able to strategize around cost-effectively.

However, there is always a debate on which costing method is better – marginal or absorption costing.

Marginal Costing vs Absorption Costing – Key Differences

Some of the major differences between the two have been listed below:

  • Marginal costing doesn’t consider fixed costs under product or inventory valuation. On the other hand, absorption costing takes both fixed and variable costs into account.
  • Marginal costing can be classified as fixed costs and variable costs. Absorption costing can be classified as production, distribution, and selling & administration.
  • The purpose of marginal costing is to show forth the contribution of the product cost. The purpose of absorption costing is to provide a fair and accurate picture of the profits.
  • Marginal costing can be expressed as a contribution per unit. Absorption costing can be expressed as net profit per unit.
  • Marginal costing is a method of costing and isn’t a conventional way of looking at costing methods. On the other hand, absorption costing is used for financial and tax reporting, and it is the most convenient method of costing.

Marginal Costing vs Absorption Costing – Comparative Table

Here is a list of differences between marginal costing and absorption costing in the tabular format:

Basis for ComparisonMarginal CostingAbsorption Costing
1. MeaningMarginal costing is a technique that assumes only variable costs as product costs.Absorption costing is a technique that assumes both fixed costs and variable costs as product costs.
2. What it’s all about?Variable cost is considered as product cost, and fixed cost is assumed as a cost for the period.Both fixed cost and variable costs are considered in product cost.
3. Nature of overheadsFixed costs and variable costs;Overheads, in the case of absorption costing, are quite different – production, distribution, and selling & administration.
4. How is the profit calculated?By using the profit volume ratio (P/V ratio)Fixed costs are considered in product costs; that’s why profit reduces.
5. DeterminesThe cost of the next unit;The cost of each unit.
6. Opening & Closing stocksSince the emphasis is on the next unit, change in opening/closing stocks doesn’t affect the cost per unit.Since the emphasis is on each unit, change in opening/closing stocks affects the cost per unit.
7. Most important aspectContribution per unit.Net profit per unit.
8. PurposeTo show forth the emphasis of contribution to the product cost.To show forth the accuracy and fair treatment of product cost.
9. How is it presented?By outlining the total contribution;Most conveniently for financial and tax reporting;