Difference Between Marginal Costing and Absorption Costing

The main difference between marginal costing and absorption costing is that in marginal costing, variable cost is treated as product cost, and fixed cost is treated as period cost. On the other hand, in absorption costing, variable and fixed costs are treated as product costs. In this article, we will explore the difference between marginal costing and absorption costing in great detail. 

Table of contents (TOC)

• Difference between marginal costing and absorption costing
• What is marginal costing?
• What is absorption costing?
• Key difference between absorption costing and marginal costing

Difference Between Marginal Costing and Absorption Costing 

For a better understanding, let’s go through the difference between marginal costing and absorption costing in a tabular format.

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What is Marginal Costing?

Marginal costing definition: Marginal Costing is a decision-making technique for determining the total cost of production.

In marginal costing, variable cost is treated as product cost and fixed cost as period cost. And this type of costing is also known as variable costing. This technique accounts for the variable costs associated with the extra units produced. In this technique, fixed expenses are not considered because they do not vary due to ongoing changes.

You can also explore: Marginal Costing: Meaning and Advantages

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Marginal costing example:

Let’s look at an example to understand better “marginal costing.” Assume there is a shoe factory that produces 100 “Black shoes,” and to produce 100 black shoes costs ₹5000. To make one more black would cost ₹800. This is the marginal cost: the cost of producing one more unit of a good or service.

Using this technique, management can easily decide, or this technique will also assist management in understanding whether increasing production to 101 or 102 will be financially beneficial.

What is Absorption Costing? 

Absorption costing definition: Absorption costing is calculating product costs considering fixed and variable costs.

Absorption costing is GAAP compliant, and contribution per unit is considered. The cost of an abortion is primarily used for external reporting to the government, tax authorities, and shareholders.

Abortion costs include direct manufacturing costs, such as direct labor and materials, and fixed overhead costs incurred during the production process, such as utility costs. Let’s go through an example to understand the term “absorption costing” in a better way.

Absorption costing example:

Assume a company produces 5,000 toys with variable costs (a variable cost is a business expense that varies based on the amount a company produces or sells) of ₹60 direct materials, ₹110 direct labor, and ₹40 variable overhead per unit. The fixed overhead is ₹100,000 in addition to the per-unit costs.

To calculate the toy cost using absorption costing, add the per-unit costs together (direct labor, direct materials, variable overhead). Following that, per-unit costs must be obtained from the fixed overhead for the per-unit overhead to be applied to the per-unit cost. The absorption costing per unit is final when the overhead is added to the per-unit costs.

Hence, absorption cost per unit: (direct materials + direct labor + variable overhead) + (fixed overhead / number of units) = (60+110+40 = ₹210) + (100,000/5000 = ₹20). So, the absorption cost per unit is ₹230.

Key Difference Between Absorption Costing and Marginal Costing 

Here are the key differences between marginal costing and absorption costing:

• While absorption costing is challenging to implement, marginal costing is simple.
• In absorption costing, contribution per unit is considered, whereas net profit per unit is considered in marginal costing.
• Absorption costing emphasizes overhead recovery, whereas marginal costing emphasizes calculating each unit’s contribution.
• The primary consideration is given to the cost of each unit in absorption costing. However, the cost of producing the next unit is prioritised in marginal costing.
• In absorption costing, variable and fixed costs are factored into the product’s price. In contrast, only variable costs are considered product costs in marginal costing, while fixed costs are classified as period costs.

Conclusion

In this article, we have explored the difference between marginal costing and absorption costing in great detail, along with their example. If you have any queries related to the article, please feel free to send your queries through comments. We will be happy to help and answer all your queries.

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