Differences between Absorption costing & Marginal Costing
COST CLASSIFICATION: Under adsorption costing, costs are classified on functional basis i.e. Production, Administration, Selling & Distribution, Research, Development etc. Under marginal costing, costs are classified as either Fixed or Variable.
PRODUCT v/s PERIOD COSTS: Under adsorption costing, fixed costs are treated as product costs. (As they are included in closing stock valuation) Under marginal costing, fixed costs are treated as period costs. They are written off in the period in which they are incurred.
STOCK VALUATION: Under absorption costing, the fixed overheads (fixed production overheads under financial accounting system and fixed production and administration overheads under cost accounting system) are charged to the output. To the extent, the output remains unsold i.e. closing stock; its valuation would include not only the variable production cost but also the fixed overheads. This implies that part of the current period's fixed cost is effectively converted into an asset and carried forward and charged to the next period. Likewise the opening stock valuation also includes the fixed overheads of previous period.
Unlike that, under marginal costing, the fixed overheads are all treated as period cost items and are charged to the period rather than the output. Accordingly, the stock valuation includes only the variable factory or production cost and not the fixed charge.
For the normal accounting purposes, absorption costing is very widely accepted but for management accounting purpose, it is only the marginal costing technique that is to be used.
The profit and loss statement based on two different methods would give us two different profit figures and the difference would be only because of stock valuation, (difference in respect of opening and closing stock), and under cost accounting, under/over absorption, if it is carried forward.
OVER /UNDER ABSORPTION: If the spent amount is different from absorbed amount then, there will be over/under absorption under absorption costing. Since all fixed costs are written off in the period in which they are incurred there is no possibility of over/under absorption.
APPLICATION: Absorption costing technique is used for external reporting purposes. It distorts decision- making.
Marginal costing technique is used for internal reporting purposes. It aids in decision- making.