Absorption Costing VS Marginal Costing- Make A Choice According To Your Interest

Absorption Costing absorbs all manufacturing/production costs in to stock valuation. These costs include direct material, direct labour, direct expenses, variable production overheads, as well as fixed production overheads. the opposite, Marginal Costing absorbs only variable manufacturing/production costs in to stock
Marginal Costing and Absorption Costing are methods which are often used to prepare profit statements, value stock, assist in pricing decisions. The methods have some notable differences, which can be reconciled though.

The process selected to cost stock or prepare the profit statement has the potential to: affect the pattern of calculated profits; influence worker behavior, provide management with relevant and useful knowledge for planning control purposes.

Advantages of Marginal Costing

Distinguishes between fixed and variable costs therefore providing relevant knowledge about costs for decision making purposes. When fixed and variable costs are split, it becomes simpler to manage costs as it gets clearer to management on how costs behave. So, by altering the activity level, for example, management can select an optimal production level.

Removes the effect of stock changes on profit and reduces the danger of dysfunctional behavior in employees. Dysfunctional behavior may occur in the case of absorption costing by encouraging managers to produce more stock than can be sold. Producing for stock has the effect of absorbing more fixed production overheads, hence reducing the cost of sale. The reduced cost of sale has the effect of improving the level of reported profits. However, it is feasible for such stock to tie up capital and even become obsolete. This is dysfunctional.

Avoids capitalization of fixed overheads in unsalable stocks. Under marginal costing, all fixed costs are treated as period costs, meaning that they are all written off in the accounting period to which they relate. So, there is no query of using stock to defer fixed cost expenses, as might be the case with Absorption Costing.

There is, however, no clear advantage in using either absorption or marginal costing. Both have their makes use of and the fact that the results from both systems can be reconciled indicates that there's strong links between the.

Advantages of Absorption Costing

Gives attention to both fixed and variable costs; that is, all production costs are thought about irrespective of whether they are variable or fixed. this is important when it comes to pricing decisions since the manufacturer can have a clear picture of the profit margin to be made on each sale, as all costs would have been incorporated in to the product cost.

Provides realistic periodic profits if company has a natural business cycle; profits are realistic in the sense that all production costs are matched to sales volume, than production volume as under Marginal Costing.

It is consistent with outside reporting requirements; in fact, International Accounting Standard Board recommends the use of absorption costing technique over marginal costing, which is thought about more useful for internal reporting.

The difference in approach by the two methods has implications for reported profits, when the stock level is changing. The fact that absorption costing can defer fixed costs until a sale is made means that when stock level is rising it reports a higher profit than marginal costing. On the other hand, when the stock level is reducing marginal costing reports a higher profit than absorption costing. These differences in the reported profits can be reconciled by taking in to account the fixed overhead
absorption rate and the extent of the change in stock.

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