Influence of marginal and absorption costing mething and their similarities

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INFLUENCE OF MARGINAL & ABSORPTION COSTING

Marginal cost is basically a part of variable cost, which includes the direct labour, Direct Material and Direct Expenses. Marginal cost should be defined as the accounting system where variable system should be charged to the cost of units and the fixed cost for the period of time which is fully aggregate contribution. Its special value is in decision making.

Marginal cost = Variable cost + Variable Overhead

The marginal cost is directly with the volume of production and marginal cost per unit is the same, which consist prime cost that is cost of direct labour, material and other variable overhead. It will be contain the fixed cost. The marginal cost is the cost which has been incurred to produce an extra unit of production is called marginal cost.

EXAMPLE

If an organization has produce 1000 unit at cost of £ 20,000

Where as if the increase in 1 unit i.e. 1001 unit and cost would be £ 20200

Then MARGINAL COST would be £ 200.

ADVANTAGES OF MARGINAL COST

Marginal cost is basically have an advantages of the cost control generally facilitated to avoiding the fixed overhead cost and concentrated on to the maintaining the consistent of marginal cost useful to various levels of management. It is basically help to understand to the variable cost and fixed costs. It also shows the relationship between the cost, price and their volumes. The marginal cost would be help to the short term profit planning by the break even charts and profit graph, and help to the management decision. With the marginal cost company can get maximum return to the business. The effects of the production and sales policies are more clearly seen and understand with the marginal cost.

DISADVANTAGES

There are certain disadvantages would be associated with the marginal costs which are as under.

It is very difficult to segregate to understand the all the cost which are basically misleading the result. It should be ignored the fixed cost, which show different picture at the time. The problem is that the over or under the overhead cost is apportioned on estimated basis and not on the actual. The time factor is also play an vital role where performance between two period will produce misleading results.

ABSORPTION COSTING

Absorption cost means the cost which includes all the manufacturing costs which are absorbed by the unit of produce. On the other hand, the cost of a finished unit in inventory will include direct material, labour and all the variable cost and fixed manufacturing overhead. Absorption costing is contrasted with variable costing or direct costing with the other manufacturing overhead.

ADVANTAGES OF ABSORPTION COSTING

In absorption costing will going to include all the cost which are related to the business activities like fixed cost, variable cost and production cost. This cost is also used for the preparation of the financial accounts when the production of the company should be remains constant but sale would be fluctuate.

DISADVANTAGES OF ABSORPTION COSTING

The disadvantages of the absorption costing would be emphasised on the total cost i.e. variable and fixed cost. It is not useful the management for the making decision about the planning and controlling.

An example show that difference between marginal cost and absorption cost.

"XYZ Ltd." is being started their operation in 2008. There is certain information available for May 2008 to July 2008 about the company's production. To calculate marginal and absorption cost.

PARTICULARS

£

Selling prices per Units

100

Direct Labour Per Units

20

Direct Material per Unit

10

Fixed Factory Overhead Per Months

30000

Variable Factory Overhead per Units

5

Fixed Selling Overheads

1000

Variable selling Overhead per Units

4

Budgeted activities which was expected that 2000 units to be each month produce and sold for each month were as follows

MAY

JUNE

JULY

UNIT SOLD

1000

800

1300

UNIT PRODUCE

1000

1300

1000

MARGINAL COST

PARTICULAR

MAY

JUNE

JULY

SALES

100000

80000

1100000

LESS : Variable Cost of Goods sold (£ 35)

35000

28000

385500

PRODUCT CONTRIBUTION MARGIN

65000

52000

71500

LESS : Variable Selling Overhead

4000

3200

4400

TOTAL CONTRIBUTION MARGIN

61000

48800

67100

LESS : Fixed factory Overhead

30000

30000

30000

Fixed Selling Overheads

1000

1000

1000

NET PROFIT

30000

32800

30100

ABSORPTION COST

PARTICULAR

MAY

JUNE

JULY

SALES

100000

80000

1100000

LESS : Cost of Goods sold (£65)

65000

52000

71500

 

 

28000

38500

ADD : Absorption of factory overhead

-

9000

-3000

GROSS PROFIT

35000

37000

35500

LESS : Fixed Selling Overhead

1000

1000

1000

Variable Selling Overhead

4000

3200

4400

NET PROFIT

30000

32800

30100

MARGINAL COST Vs ABSORPTION COST

After using the two techniques we had seen that the net profit would not be same at every time because of following reason.

Over and Under Absorption overhead cost

In absorption costing, fixed overhead can never absorbed exactly because of difficulty in forecasting cost and volume of output. If these balance of under or over absorbed because of costing profit and loss account, the actual amount incurred is not shown in it, whereas marginal costing is actually fixed overhead incurred in wholly charged against contribution which will be some difference in net profits.

Difference in Stock Valuation

In marginal costing work in progress and finished stock are valued at marginal cost but in absorption cost it is calculated as production cost, and that is the reason profit will be different

Many of time absorption cost and marginal cost result would be find as

Absorption costing profit = Marginal costing profit

Absorption costing profit > Marginal costing profit

Absorption costing profit < Marginal costing profit

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