There are mainly two techniques of product costing and income determinationAbsorption Costing: This is a total cost technique under which total cost (i.e., fixed cost as well as
variable cost) is charged as production cost. In other words, in absorption costing, all manufacturing
costs are absorbed in the cost of the products produced.
Marginal Costing: An alternative to absorption costing is marginal costing, also known as ‘variable
costing’ or direct costing. Under this technique, only variable costs are charged as product costs and
included in inventory valuation. Fixed manufacturing costs are not allotted to products but are
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Marginal costing and
• In marginal costing, prices are based on marginal cost plus contribution.
• In this, profit is calculated by a two-stage approach. First all, contribution is
determined for each product or department which are pooled together called
‘Fund’. Then from this fund is deducted the total fixed cost to arrive at a profit or
Absorption Costing Vs Marginal Costing
• In marginal costing, only variable costs are charged to products. Fixed costs are treated as
period costs and charged to Profit and Loss Account of the period. In absorption
costing, all costs (both fixed and variable) are charged to the product.
• In marginal costing, stock of work-in-progress and finished goods are valued at
marginal cost only. In absorption costing, stocks are valued at total cost which includes
both fixed and variable costs. Thus stock values in marginal costs are lower than
that in absorption costing.
• In marginal costing, relative profitability of products or departments is based on a study
of relative contribution made by respective products or departments. The managerial
decisions are thus guided by contribution. In absorption costing, relative profitability is
judged by profit figures which is also a guiding factor for managerial decisions.
Income Statement (Absorption Costing)
Income Statement ( Marginal Costing)
Difference in Profit Due to Difference in Costing
Profit under the two systems is different because of difference in stock valuation.
Production is equal to sales
Production is more than sales:
Production is less than sales
• (i) When there are no opening
and closing stock, profit/loss
under absorption and marginal
costing systems are equal.
• (ii) When opening stock is equal to
closing stocks then also profit/loss
under the two systems will be equal
provided the fixed cost element in
opening and closing stocks is the
• When production during a period
is more than sales, i.e., when
closing stock is more than opening
stock, the profit as per
absorption costing will be more
than that shown by marginal
costing. This is because in
absorption costing a part of fixed
overheads included in closing stock
value is carried forward to next
accounting period in the form of
• When production during a period
is less than sales, i.e., when opening
stock is more than closing stock,
profit shown by marginal costing
will be more than that shown by
absorption costing. This is because
under absorption costing, cost of
goods sold is higher because a part
of fixed cost from the preceding
period is added to the current
year’s cost of goods sold in the
form of opening stock.
Cost-Volume- Profit Analysis
Cost-volume-profit analysis (CVP analysis) is an extension of the principles of marginal costing. It...