Absorption Costing

Absorption costing: * It is costing system which treats all manufacturing costs including both the fixed and variable costs as product costs * In absorption costing, all costs are absorbed into production and thus operating statements do not distinguish between fixed and variable costs. * Absorption costing is a process of tracing the variable costs of production and the fixed costs of production to the product.

Absorption costing is used to cost products and to report financial performance. The cost of a product is made up of those direct costs that can be related directly to making it.
For example the direct cost of a chair might be:
10 metres of wood at £6.00 per metre
1 piece of moulded plastic
20 screws and washers
30 minutes of time

Marginal costing: * It is a costing system which treats only the variable manufacturing costs as product costs. The fixed manufacturing overheads are regarded as period cost * In marginal costing, fixed production costs are treated as period cost and are written off as they are incurred

The difference between marginal costing & absorption costing is as below: 1. Under marginal costing: for product costing & inventory valuation, only variable cost is considered whereas, Under absorption costing; for product costing & inventory valuation, both fixed cost & variable cost are considered. 2. Under marginal costing, there is a different treatment of fixed overhead. Fixed cost is considered as period cost & by Profit/Volume ratio (P/V ratio), profitability of different products is judged. On the other hand, under absorption costing system, the fixed cost is charged to cost of production. A reasonable share of fixed cost is to be borne by each product & thereby subjective apportionment of fixed overheads influences the profitability of product. 3. Under marginal costing, the presentation of data is so oriented that total contribution & contribution from each