Absorption and Marginal

Costing
Prepared by Mr Rabeel Sabar
Direct and Indirect Costs
Direct costs are those costs that
can be specifically traced to the
cost object.

Indirect costs are costs that cannot
be specifically traced to the cost
object.
Direct
Materials
Direct
Labor
Indirect
Labor
Indirect
Materials
Other
Manufacturing Overhead
Product Costs
All costs incurred in getting product to saleable
condition
Period costs
All costs incurred for a period of
time regardless of production
Sometimes classified into:
Marketing expenses
General (administrative)
expenses
Financial expenses
Fixed and Variable Costs
Fixed costs
Those costs that in total will remain the
same for a period of time and over a
relevant range or output.
Rent or Insurance
Variable costs
Those costs that in total will tend to
increase as output level increase.
Direct Materials or Labour
Cost of Goods Sold
Finished Goods Inventory
Beginning inventory
+ Cost of goods manufactured
= Cost of goods available for sale
Ending inventory
= Cost of goods sold
Absorption Costing
It is costing system which treats all
manufacturing costs including both
the fixed and variable costs as
product costs.

It is required for external finanical
reporting purposes.
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 costs.

It helps in internal decision making
process.
Overview of Absorption and
Marginal Costing
The only cost of driving my car
on a 200 mile trip today is
$12 for gasoline.
Variable
Costing
Overview of Absorption and
Marginal Costing
No! You must consider these costs too!
Absorption
Costing
Cost Per month Per day
Car payment 300.00 $ 10.00 $
Insurance 60.00 2.00
Overview of Absorption and Marginal
Costing
You are wrong. I have the car
payment and the
insurance payment even if
I do not make the trip.
Variable
Costing
Overview of Absorption and Marginal
Costing
Whos right?
How should we treat the car
payment and the insurance?
Overview of Absorption and
Variable Costing
Direct Materials
Direct Labor
Variable Manufacturing Overhead
Fixed Manufacturing Overhead
Variable Selling and Administrative Expenses
Fixed Selling and Administrative Expenses
Variable
Costing
Absorption
Costing
Product
Costs
Period
Costs
Product
Costs
Period
Costs
Income Analysis Under Variable Costing
and Absorption Costing
Frand Manufacturing Company
has no beginning inventory and
sales are estimated to be 20,000
units at $75 per unit, regardless of
production levels.
Income Analysis Under Variable Costing
and Absorption Costing
Proposal 1: 20,000 Units to Be Manufactured and Sold
Total Cost Unit Cost
Manufacturing costs:
Variable $ 700,000 $35
Fixed 400,000 20
Total costs $1,100,000 $55
Selling and administrative exp.
Variable ($5 per unit sold) $ 100,000
Fixed 100,000
Total expenses $ 200,000
Income Analysis Under Variable Costing
and Absorption Costing
Total Cost Unit Cost
Manufacturing costs:
Variable $ 875,000 $35
Fixed 400,000 16
Total costs $1,275,000 $51
Selling and administrative exp.
Variable ($5 per unit sold) $ 100,000
Fixed 100,000
Total expenses $ 200,000
Proposal 2: 25,000 Units to Be Manufactured; 20,000 Units to Be Sold
Frand Manufacturing Company
Absorption Costing Income Statements
20,000 Units
Manufactured
25,000 Units
Manufactured
Sales $1,500,000 $1,500,000
Cost of goods sold:
Cost of goods manufactured
(20,000 units x $55) $1,100,000
Frand Manufacturing Company
Absorption Costing Income Statements
20,000 Units
Manufactured
25,000 Units
Manufactured
Sales $1,500,000 $1,500,000
Cost of goods sold:
Cost of goods manufactured
(20,000 units x $55) $1,100,000
(25,000 units x $51) $1,275,000
Frand Manufacturing Company
Absorption Costing Income Statements
20,000 Units
Manufactured
25,000 Units
Manufactured
Sales $1,500,000 $1,500,000
Cost of goods sold:
Cost of goods manufactured
(20,000 units x $55) $1,100,000
(25,000 units x $51) $1,275,000
Less ending inventory:
(5,000 units x $51) 255,000
Cost of goods sold $1,100,000 $1,020,000
Gross profit $ 400,000 $ 480,000
Selling and administrative expenses
($100,000 + $100,000) 200,000 200,000
Income from operations $ 200,000 $ 280,000
Frand Manufacturing Company
Variable Costing Income Statements
20,000 Units
Manufactured
25,000 Units
Manufactured
Sales $1,500,000 $1,500,000
Variable cost of goods sold:
Variable cost of goods manufactured:
(20,000 units x $35) $ 700,000
(25,000 units x $35) $ 875,000
Frand Manufacturing Company
Variable Costing Income Statements
20,000 Units
Manufactured
25,000 Units
Manufactured
Sales $1,500,000 $1,500,000
Variable cost of goods sold:
Variable cost of goods manufactured:
(20,000 units x $35) $ 700,000
(25,000 units x $35) $ 875,000
Less ending inventory:
(0 units x $35) 0
(5,000 units x $35) 175,000
Variable cost of goods sold $ 700,000 $ 700,000
Manufacturing margin $ 800,000 $ 800,000

Continued
Frand Manufacturing Company
Variable Costing Income Statements
20,000 Units
Manufactured
25,000 Units
Manufactured
Manufacturing margin $ 800,000 $ 800,000
Variable selling and administrative
expenses 100,000 100,000
Contribution margin $ 700,000 $ 700,000
Fixed costs:
Fixed manufacturing costs $ 400,000 $ 400,000
Fixed selling and administrative
expenses 100,000 100,000
Total fixed costs $ 500,000 $ 500,000
Income from operations $ 200,000 $ 200,000
IF
Units Sold < Units produced
THEN Variable Costing < Absorption Costing
Income Income
IF
Units Sold > Units produced
THEN Variable Costing > Absorption Costing
Income Income
Absorption costing Marginal costing


Treatment for
Fixed
Manufacturing
Overheads
Fixed
manufacturing
overheads are
treated as product
costing. It is
believed that
products cannot be
produced without
the resources
provided by fixed
manufacturing
overheads
Fixed manufacturing
overhead are treated
as period costs. It is
believed that only the
variable costs are
relevant to decision-
making.
Fixed manufacturing
overheads will be
incurred regardless
there is production or
not
Absorption costing Marginal costing
Value of
Closing Stock
High value of
closing stock will be
obtained as some
factory overheads
are included as
product costs and
carried forward as
closing stock
Lower value of
closing stock that
included the variable
cost only