Inventory valuation is a major component in the calculation of the cost of goods sold and can be used as collateral for loans. It can be defined as the cost associated with the inventory in an entity at the end of the reporting period. Inventory valuation is based on the costs incurred by an entity to acquire the inventory. Show
The importance of inventory valuation is;
There are two commonly used approaches in the valuation of inventory. These are absorption costing and marginal costing. What is an Absorption Costing?Also referred to as full costing, it is a costing system whereby all manufacturing costs, including variable and fixed costs, are assumed to be product costs. The period costs, in this case, include administrative, selling and general costs which do not go into the cost of the product but are expensed at the period incurred. The product costs including variable manufacturing overhead, direct labor, fixed manufacturing overhead, and direct material are costs that go into the product. The advantages associated with absorption costing include;
It, however, has some disadvantages
What is a Marginal Costing?A marginal cost is the cost of one additional unit of output. Marginal costing is a costing technique whereby the marginal cost is charged to units of costs while the fixed cost is completely written off against the contribution. Marginal costing is helpful in certain decision making in a business on matters such as whether to carry on with a service or product, replacement of machinery and in ascertaining the appropriate level of activity, through the break-even analysis. This helps in the reflection on how the overall profit is affected by the decrease or increase in production levels. In marginal costing;
Advantages of marginal costing are;
It, however, has some disadvantages
Similarities between absorption costing and marginal costing
Differences between Absorption Costing and Marginal Costing
Absorption costing is a costing system whereby all manufacturing costs, including variable and fixed costs, are classified as part of product costs while marginal costing is a costing technique whereby the marginal cost is charged to units of costs while the fixed cost is completely written off against the contribution.
In absorption costing, both variable and fixed costs are considered in the cost of the product. On the other hand, in marginal costing, only variable costs are considered as product cost and fixed costs are classified as period costs.
In absorption costing, contribution per unit is considered while in marginal costing, net profit per unit is considered.
In absorption costing, major consideration on the cost of each unit is given priority. However, in marginal costing, major consideration on the cost of producing the next unit is given priority.
Absorption costing emphasizes overheads recovery while marginal costing emphasizes the calculation of the contribution of each unit.
In absorption costing, overheads are classified into administration, production, distribution and selling overheads. On the other hand, in marginal costing, overheads are classified into fixed and variable overheads.
While absorption costing is not easy to operate, marginal costing is easy to operate.
In absorption costing, the cost per unit is affected by variances in the opening and closing stock while in marginal costing the cost per unit is not affected by variances in the opening and closing stock.
While absorption costing is GAAP compliant, marginal costing is not GAAP compliant.
Absorption costing is used for external reporting to the government, tax authorities and shareholders while marginal costing is used for internal reporting particularly to the management for decision making.
While absorption costing is not very helpful in making managerial decisions, marginal costing is helpful in decision making due to the fact that it considers additional costs involved. Absorption costing vs. Marginal costing: Comparison TableSummary of Absorption Costing vs. Marginal CostingProfits generated differ, depending on which costing method is used. This is because the absorption costing method includes fixed production costs to the output while the marginal costing method does not. Absorption costing also creates variances in the budgeted and actual levels because fixed overheads remain the same, irrespective of the levels of output. Both can be used, depending on an entity’s preference and business models.
Tabitha graduated from Jomo Kenyatta University of Agriculture and Technology with a Bachelor’s Degree in Commerce, whereby she specialized in Finance. She has had the pleasure of working with various organizations and garnered expertise in business management, business administration, accounting, finance operations, and digital marketing. Loading... Email This Post : If you like this article or our site. Please spread the word. Share it with your friends/family. Cite What is the difference between full absorption costing and variable costing?Absorption costing entails allocating fixed overhead costs to all units produced for an accounting period. Variable costing includes all of the variable direct costs in COGS but excludes direct, fixed overhead costs.
What is the basic difference between absorption costing and marginal variable costing?Marginal costing is based on classifying costs by behaviour, in other words, whether a cost is variable or fixed. Absorption costing focuses on whether a cost is direct or indirect by nature.
What is the difference between full absorption costing and variable costing quizlet?What is the difference between full absorption costing and variable costing? In full absorption costing, fixed manufacturing overhead is included in the cost of the product. In variable costing, fixed manufacturing overhead is expensed.
What is the difference between full costing and marginal costing?Full-cost pricing is a common strategy that factors the entire overhead into the product pricing, while marginal cost pricing is designed to move inventory without necessarily turning a profit.
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