Difference between marginal and absorption costing profit

The net profit calculated under marginal and absorption are not the same. The difference came about due to the following reasons: 1. Treatment of fixed manufacturing overheads Fixed manufacturing overheads are treated as product cost under absorption costing. It is believed that products cannot be produced without the resources provided by fixed manufacturing overheads. Hence fixed manufacturing overheads is carried between accounting periods as part of inventory valuation. Under marginal costing fixed manufacturing overheads are treated as period cost. It is believed that only the variable cost are relevant to decision making. Fixed manufacturing overheard will be incurred regardless there is production or not. Hence Fixed manufacturing overheads is written off against contribution in the period that it occurs. 2. Valuation of closing stock Marginal costing has a lower cost build because work-in-progress and finish goods are valued at variable production cost of a unit of a product which excludes fixed overheard. Under absorption costing a high value of closing stock is obtained because fixed overheads is included as product and carried forward as closing stock, hence the cost build up is higher. In the absence of opening and closing stock, there will be no difference in profits under marginal and absorption costing.

3. Difference between production and sales Reconciliation of profit Jan GH Profit under Absorption 23,550 Difference in units of inventory Fixed production overhead p/u 3,750 (100 X 37.5) Profit under marginal costing 19,800

Feb GH 23250

Mar GH 20625

18, 750 (500 X 37.5) 9,375 (250 X37.5) 4,500 30,000

When production exceeds sales, assuming there is no opening stock, there is the likelihood that there will be closing stock then absorption costing profit will be higher than marginal profit. When production is less that sales absorption profit is lower than marginal profit. When production equal sales there is no difference in profit.

4. Over/Under absorption of overhead Over and under absorption of fixed overhead occur in absorption costing.