Marginal costing and absorption costing are two different approaches used in managerial accounting for the allocation of production costs to products. Here are the key differences between marginal costing and absorption costing:
Marginal Costing:
Focus on Variable Costs:
Marginal Costing: Focuses on variable costs (direct costs) associated with production, such as direct materials, direct labor, and variable manufacturing overhead.
Treatment of Fixed Costs:
Marginal Costing: Treats fixed manufacturing overhead costs as period costs. Fixed production costs are not assigned to units produced but are treated as expenses in the period in which they are incurred.
Income Statement Presentation:
Marginal Costing: Presents the contribution margin (sales revenue minus variable costs) as a key figure on the income statement. Fixed production costs are not deducted from the contribution margin to calculate gross profit.
Decision-Making Focus:
Marginal Costing: Particularly useful for decision-making purposes, such as setting prices, determining product mix, and making short-term business decisions.
Variable Costing:
Marginal Costing: Often referred to as variable costing because it emphasizes the variable costs associated with production.
Absorption Costing:
Inclusion of Fixed Costs:
Absorption Costing: Allocates both variable and fixed manufacturing costs to products. Fixed production costs are considered part of the product cost and are included in the inventory valuation.
Treatment of Fixed Costs:
Absorption Costing: Allocates fixed manufacturing overhead costs to units produced based on a predetermined overhead rate. These costs become part of the product cost until the products are sold.
Income Statement Presentation:
Absorption Costing: Presents gross profit as sales revenue minus the cost of goods sold (COGS), which includes both variable and fixed manufacturing costs.
Inventory Valuation:
Absorption Costing: Results in different inventory valuation figures compared to marginal costing. Fixed production costs are capitalized in inventory until the products are sold.
Compliance with GAAP:
Absorption Costing: Generally complies with Generally Accepted Accounting Principles (GAAP) for external financial reporting, as fixed production costs are treated as part of the cost of goods sold.
Summary:
Marginal Costing: Focuses on variable costs, treats fixed manufacturing costs as period costs, and is often used for short-term decision-making. The income statement emphasizes contribution margin.
Absorption Costing: Allocates both variable and fixed manufacturing costs to products, treats fixed manufacturing costs as part of product cost, and is generally used for external financial reporting. The income statement emphasizes gross profit.
The choice between marginal costing and absorption costing depends on the specific reporting requirements, decision-making needs, and the desired treatment of fixed manufacturing costs.