MARGINAL COSTING VS. ABSORPTION COSTING

What is Marginal Costing?

  • ๐Ÿ“Š Definition: What is marginal costing, and how does it differ from absorption costing?

Key Features of Marginal Costing

  • ๐ŸŽฏ Cost Classification: How are costs classified under marginal costing?
    • Marginal costing categorizes costs into fixed and variable components, with variable costs directly attributable to production volume and fixed costs remaining constant regardless of production levels.
  • ๐Ÿ“ˆ Cost Allocation: How are costs allocated in marginal costing?
    • Marginal costing allocates only variable manufacturing costs to products, treating fixed manufacturing costs as period costs expensed in the period incurred.
  • ๐Ÿข Contribution Margin: What role does contribution margin play in marginal costing?
    • Contribution margin is the difference between sales revenue and variable costs, representing the amount available to cover fixed costs and contribute to profit.

What is Absorption Costing?

  • ๐Ÿ“Š Definition: How does absorption costing differ from marginal costing in terms of cost allocation and profit determination?

Key Features of Absorption Costing

  • ๐ŸŽฏ Cost Allocation: How are costs allocated under absorption costing?
    • Absorption costing assigns both variable and fixed manufacturing costs to products, including fixed manufacturing overhead in the cost of inventory.
  • ๐Ÿ“ˆ Cost Absorption: What does absorption costing aim to achieve in terms of cost absorption?
    • Absorption costing aims to fully absorb all manufacturing costs into the cost of inventory, regardless of whether products are sold or remain in inventory.
  • ๐Ÿข Treatment of Fixed Costs: How are fixed manufacturing costs treated under absorption costing?
    • Fixed manufacturing costs are included in the cost of inventory and expensed through cost of goods sold when products are sold.

Comparison of Marginal Costing and Absorption Costing

  • ๐Ÿ’ผ Profit Determination: How do marginal costing and absorption costing differ in determining profit?
    • Marginal costing focuses on contribution margin and separates fixed costs from variable costs, while absorption costing considers total manufacturing costs, including fixed overhead, in determining profit.
  • ๐Ÿ“Š Inventory Valuation: How do marginal costing and absorption costing differ in valuing inventory?
    • Marginal costing values inventory at variable production costs only, while absorption costing includes both variable and fixed production costs in inventory valuation.
  • ๐ŸŽฏ Decision Making: How does the choice between marginal costing and absorption costing impact decision-making processes?
    • Marginal costing provides clearer insights into the contribution of each product to covering fixed costs and making decisions about pricing, product mix, and capacity utilization.
See also  BREAK-EVEN ANALYSIS AND ITS LIMITATIONS

Understanding the differences between marginal costing and absorption costing is essential for businesses to choose the most appropriate costing method based on their specific needs, objectives, and decision-making requirements. Each method has its advantages and limitations, and selecting the right approach can significantly impact financial reporting, performance evaluation, and strategic decision-making.

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