Absorption and

marginal costing

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Introduction
 There are mainly two techniques of product costing & income
determination:
1. Absorption costing (Full costing)
- It is costing system which treats all manufacturing costs including both
the fixed and variable costs as product costs.
- We allocate all manufacturing costs to products regardless of whether
they are fixed or variable.
- It comply with GAAP.

2. Marginal costing (Variable 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
- Only variable costs are relevant to decision-making.
- This facilitates C-V-P analysis.
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Overview of Absorption and
Variable Costing
Absorption Variable
Costing Costing

Direct materials
Direct labour Product costs
Product costs Variable mfg. overhead

Fixed mfg. overhead

Period costs
Period costs Selling & admin. exp.

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Absorption costing vs. Marginal costing
Absorption costing Marginal costing
Treatment of fixed All the costs are charged to Only variable cost are
cost product. charged to products.
Fixed costs are treated
as period cost.
Valuation of stock Stock of FG is valued at total Stock of FG is valued at
costs. Stock value is higher as marginal cost only. Stock
fixed costs are included in value is lower.
product cost.
Measurement of Profitability is judged by profit Profitability is based on a
profitability amount which is also a guiding study of contribution
factor for managerial made by the product,
decisions. which is the guiding
factor.
Reported profit:
Production = sales Absorption costing profit = Marginal costing profit
Production > sales Absorption costing profit > Marginal costing profit
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Production < sales Absorption costing profit < Marginal costing profit
Income statement (Absorption costing)
Rs. Rs.
Sales XXX
Production cost:
Direct material Xx
Direct labour Xx
Variable manufacturing OH Xx
Fixed manufacturing OH Xx
Cost of production XXX
Add: Opening stock of finished goods XXX
(valued at a cost of previous period’s production)
Less: Closing stock of finished goods XXX
(valued at a cost of current period’s production)
Cost of goods sold XXX
Add: Variable Administration cost, Selling & distribution costs Xx
Fixed Administration cost, Selling & distribution costs Xx XXX
Total cost XXX
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Profit XXXX
Income statement (Marginal costing)
Rs. Rs.
Sales XXX
Variable manufacturing costs
Direct material Xx
Direct labour Xx
Variable manufacturing OH Xx
Cost of production XXX
Add: Opening stock of finished goods XXX
(valued at variable cost of production of previous period)
Less: Closing stock of finished goods XXX
(valued at variable cost of current period’s production)
Cost of goods sold XXX
Add: Variable Administration cost, Selling & distribution costs XX
Total variable cost XXX
Contribution (Sales – Total variable costs) XXX
Less: Fixed Production, Administration, Selling & distribution costs XX6
Profit XXXX
Illustration 1
 Zen ltd supplies you the following data:
 Direct material cost Rs. 48,000
 Direct labour Rs. 22,000
 Variable OH: Factory Rs. 13,000
: Admin & Selling Rs. 2,000
 Fixed OH: Factory Rs. 20,000
: Admin & selling Rs. 8,000
 Sales Rs. 1,25,000
 Prepare an income statement as per absorption costing
& marginal costing.
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Illustration 2
ABC ltd sells its productions at Rs. 3 per unit. The company uses
FIFO costing system. Prepare income statement based on
absorption & marginal costing. The following data are related
to its first 2 years of operation:
Year I Year II
Sales (Units) 1000 1200
Production (Units) 1400 1000
Variable manufacturing cost Rs. 700 Rs. 500

Fixed manufacturing Rs. 700 ?

Variable marketing & administration OH Rs. 1000 Rs. 1200

Fixed marketing & administration OH ? Rs. 400

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Illustration 3
 A company started its business in 2005. The following information
was available for January to March 2005 for the company that
produced a single product:
 Selling price pre unit 100
 Direct materials per unit 20
 Direct Labour per unit 10
 Fixed factory overhead per month 30000
 Variable factory overhead per unit 5
 Fixed selling overheads 1000
 Variable selling overheads per unit 4

 Budgeted activity was expected to be 1000 units each month

 Production and sales for each month were as follows:
 Jan Feb March
 Unit sold 1000 800 1100
 Unit produced 1000 1300 900
 Prepare income statement under absorption & marginal costing.
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Definition
 Breakeven analysis is also known as cost-
volume profit analysis
 Breakeven analysis is the study of the
relationship between selling prices, sales
volumes, fixed costs, variable costs and
profits at various levels of activity

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Cost-Volume-Profit Graph

Break-even Total sales

point
rea
f it a
o
Sales in Dollars

Pr
Total expenses

Fixed expenses
r ea
s sa
Lo

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Units Sold
Cost sheet

Amt.
Sales (S) XXX
Less: Variable cost (V) XXX
Contribution (C) XXX
Less: Fixed cost (FC) XXX
Profit (P) XXX

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Illustration 1
A product is sold at Rs. 80 p.u, It’s Variable
cost is Rs. 60. Fixed cost is Rs. 6,00,000.
Compute the following:
 P/V Ratio
 BEP Units and Value
 MS at a sales of 50,000 Units

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Illustration 2
 The following data is given:
 Selling price Rs. 20 p.u.
 Variable manufacturing costs Rs. 11 p.u.
 Variable selling costs Rs. 3 p.u.
 Fixed factory overheads Rs. 540,000 p.a.
 Fixed selling costs Rs. 252,000 p.a.
 Compute:
i) P/V ratio & BEP value
ii) No. of units that must be sold to earn profit of Rs.
60,000 p.a.
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Illustration 3
KT & Co. has prepared the following budget estimates
for the year 2002-2003.
 Sales 15,000 units,

 Sales value Rs. 1,50,000,

 Fixed cost Rs. 34,000,

 Variable cost per unit Rs. 6.

 You are required to find: P/V ratio; BEP and MS

 Also calculate revised P/V ratio; BEP and MS, if

selling price per unit is reduced by 10%.
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Quick Review Question # 1

1. Which of the following lends itself well to

C-V-P Analysis?
a. Full Costing

b. Absorption Costing

c. Variable Costing

d. Average Costing

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Quick Review Question # 2

2. Which of the following complies with

GAAP for external reporting purposes?
a. Absolute costing

b. Variable costing

c. Fixed costing

d. Absorption costing

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Quick Review Question # 3

3. Which of the following lends itself well to

internal decision making?
a. Full costing

b. Variable costing

c. Absorption costing

d. None of these

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Quick Review Question # 4

4. If total FC of the firm is Rs. 12,000, selling

price is Rs. 12 per unit & Variable cost
Rs. 9 per unit, then BEP units are?
a. 40,000

b. 4,000

c. 400

d. None of these

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