Absorption and Marginal Costing

[LBCstudent]

Hey there,i have been given an assignment to explain marginal and absorption costing and discuss their impact on stock valuation an d profit measurement....can you help please?
Its for BBA level(Bachelors in Business Administration)[D]

[Salmancert]

Hey, so whats the problem? Go ahead and explain them. This is an easy topic even a CAT student can answer

[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
------------------------------------------------------

(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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[mushi]

Prime cost = all direct costs
<b> AND</b>
When comparing profits of both marginal and absorption

the profit under both methods will be same if there is no change in closing stock level!!
and if there is a change-
if closing stock increases than opening stock then profit under absorption will be greater than marginal. and if closing stock decreases then profit will be higher using marginal costing!

MUBASHIR 'CAT'

[Muhammad Adnan Arshad]

(A) If Production Volume > Sales Volume, then
Profit under Absorption Costing > Profit under Marginal Costing
& it shows that there is a building-up of inventory/stock levels (or stocking).

(B) If Production Volume < Sales Volume, then
Profit under Absorption Costing < Profit under Marginal Costing
& it shows that there is a running-out of stocks (or destocking).

(C) If Production Volume = Sales Volume, then
Profit under Absorption Costing = Profit under Marginal Costing
& it shows that there is a constant/static inventory (or stocks) levels.

PROFITS RECONCILIATION STATEMENT-

PROFIT UNDER ABSORPTION COSTING TECHNIQUE

LESS
Closing Stock-AC
Opening Stock-MC

ADD
Closing Stock-MC
Opening Stock-AC

= PROFIT UNDER MARGINAL COSTING TECHNIQUE

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[awaisaftab]

<blockquote id="quote"><font size="1" face="Verdana, Arial, Helvetica, san" id="quote">quote<hr height="1" noshade id="quote"><i>Originally posted by Salmancert</i>
<br />Hey, so whats the problem? Go ahead and explain them. This is an easy topic even a CAT student can answer
<hr height="1" noshade id="quote"></font id="quote"></blockquote id="quote">
Dear Salmancert Mr.LBCstudent has mentioned in his post that he is a student of BBA. Ussually in BBA and MBA advance cost and management accounting is not taught. So it is not so simple for LBCstudent to explain absorption costing and marginal costing as conveniently as a professional accountant can do.

Regards