There are accountants who favour each costing method.
Arguments in favour of absorption costing are as follows:
- Fixed production costs are incurred in order to make output; it is therefore ‘fair’ to charge all output with a share of these costs.
- Closing stock values by including a share of fixed production overhead will be valued on the principle required for the financial accounting valuation of stocks by
Statement of standard accounting practice on stocks and long-term contracts (SSAP 9).
- A problem with calculating the contribution of various products made by a company is that it may not be clear whether the contribution earned by each product is enough to cover fixed costs, whereas by charging fixed overhead to a product it is possible to ascertain whether it is profitable or not.
Arguments in favour of marginal costing are as follows:
- It is simple to operate
- There are no apportionments, which are frequently done on the arbitrary basis, of fixed costs. Many costs, such as the managing director’s salary, are indivisible by nature.
- Fixed costs will be the same regardless of the volume of output, because they are period costs. It makes since therefore, to charge them in full as a cost to the period.
- The cost to produce an extra unit is the variable production cost. It is realistic to value closing stock items at this directly attributable cost.
- Under or over absorption of overheads is avoided.
- Marginal costing information can be used for decision-making but absorption costing information is not suitable for decision-making.
- Fixed costs (such as depreciation, rent and salaries) relate to a period of time and should be charged against the revenues of the period in which they are incurred.
Of course, the choice of method does not have to be between absorption costing and marginal costing. We looked at ABC as an alternative to absorption costing. Attributable contribution costing is another alternative. This involves attributing certain fixed costs to the activities which cause them and then using marginal costing to calculate a contribution for each activity, the surplus of contribution over attributable fixed costs being known as attributable contribution.
Absorption costing is most often used for routine profit reporting and must be used for financial accounting purposes. Marginal costing provides better management information for planning and decision-making.
Marginal cost is an important measure in marginal costing, and it is calculated as the difference between sales value and marginal or variable cost.
In marginal costing, fixed production costs are treated as period costs and are written off as they are incurred. In absorption costing, fixed production costs are absorbed into the cost of units and are carried forward in stock to be charged against sales for the next period. Stock values using absorption costing are therefore greater than those calculated using marginal costing.
Reported profit figures using marginal costing or absorption costing will differ if there is any change in the level of stocks in the period. If production is equal to sales, there will be no difference in calculated profits using these costing methods.
SSAP 9 recommends the use of absorption costing for the valuation of stocks in financial accounts.
There are a number of arguments both for and against each of the cosign systems.
The distinction between marginal costing and absorption costing is very important and it is vital that you now understand the contrast between the two systems.
- Define contribution
- How are stocks valued in marginal costing?
- If opening and closing stock volumes and values are the same, does absorption costing or marginal costing give the higher profit?
- What are the arguments in favour of the use of marginal costing?
Other Custom Business Writing services
Businesswritingservices.org offers other custom business writing services such as Management writing services: Management essays, Management Dissertations, Management company analysis, Management Research papers and term papers: Finance writing services: Finance essays, Finance Dissertations, Finance case study analysis, Finance Research papers and term papers: Economics Writing Services: Economics essays, Economics Dissertations, Economics thesis, Economics Research papers and Economics term papers: Marketing Writing Services: Marketing essays, Marketing Dissertations, Marketing company analysis, Marketing Research papers and term papers:Business Writing Services: Business Essay, Business Research paper, Business term paper, Business Dissertation, Business Thesis, Business Case study: Auditing Writing Services: Auditing essays,Auditing Research papers, Auditing term papers, Auditing Dissertation, Auditing Thesis, Auditing Case study: Business information systems: Business information systems essays, Business information systems Research papers, Business information systems term papers, Business information systems Dissertation, Business information systems Thesis, Business information Case study: Taxation writing services: Taxation essays, Taxation Research papers, Taxation term papers, Taxation Dissertation, Taxation Thesis, Taxation Case study:Human resources writing services: Human resources essays, Human resource Dissertation, Human resources Thesis, Human resources case study, Human resources Research papers and term papers: Business law writing services: Business law essays, Business law Research papers and term papers, Business law dissertation, Business Thesis, Business law case study. Join the rest of our Business Writing services at Business Writing Services.org.