Absorption and Marginal Costing

[Muhammad Adnan Arshad]

PRODUCT COSTING TECHNIQUES-
In cost accounting, the cost of production can be computed/measured under the two major product costing techniques. One is called "absorption costing" & other one is "marginal costing".

(a) ABSORPTION COSTING; FULL PRODUCT COSTING
Absorption costing is a traditional product costing technique used in the Cost & Management Accounting. In absorption costing technique, both fixed & variable prduction overheads (or factory overheads (FOHs)) are fully absorbed into the cost of production. Factory overheads are calculated on the estimation/absorption basis instead of taking actually incurred factory overheads' figure. i.e;

FOH-Absorbed/FOH-Applied=[Appropriate Base(actual)]X[Overhead Absorption Rate(OAR)]
Where,
Appropriate Base may be any of the followings;
*Direct Materials Cost (DMC);
*Direct Labour Cost (DLC);
*Prime Cost/Direct Cost/Flat Cost/Basic Cost (DMC+DLC);
*Direct Labour Hours;
*Machine Running Hours;
*Nomber of units produced/Output/Prodution/Sales.

& OAR = (Budgeted Factory Overheads/Budgeted Base)

So,
Sales Revenue
Less Cost of Sales (DMC+DLC+Variable-FOHs+Fixed-FOHs)
------------------------------------------------------
=GROSS PROFIT MARGIN
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(b) MARGINAL COSTING; DIRECT COSTING; VARIABLE COSTING
In marginal costing technique, only variable production overheads are included into the cost of production (or cost of sales). Fixed production overheads are deducted from the contribution margin as "period costs" to ultimately give the net profit/loss figure.

So,
Sales Revenue
Less Variable Cost of Sales (DMC+DLC+Variable-FOHs)
----------------------------------------------------
=GROSS CONTRIBUTION MARGIN
Less Fixed Costs
----------------------------------------------------
=NET PROFIT/(LOSS)
----------------------------------------------------

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