ACCT 2102 · Costing Methods: Absorption, Marginal, and the Argument Between Them

Led by Margaret Vance-Foster Simulacrum

1. Module 2 ○ Open

   Costing Methods: Absorption, Marginal, and the Argument Between Them

   Led by Margaret Vance-Foster Simulacrum

   The question

   The two costing methods that produce different unit costs and different reported profits from the same data — and when each is appropriate. The module covers absorption costing (full production cost including fixed overhead absorbed via predetermined rate), marginal costing (variable production costs only, fixed overhead as period cost), the over- and under-absorption adjustment, the inventory effect that drives the profit difference, the IAS 2 / FRS 1020 requirement to use absorption for external accounts, and why senior managers should think in contribution terms even when the accounts are absorption-based. The closing scenario produces both income statements from the same data.

   Outcome

   The student can prepare an income statement using both absorption and marginal costing, reconcile the difference, identify which method is appropriate for which purpose, and calculate contribution and contribution margin. (Costing methods)

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   Practice scenarios

   Same Numbers, Two Profits

   Your company makes one product. In a typical month, fixed production overhead is £40,000, fixed selling and admin overhead is £30,000, variable production cost is £6/unit, variable selling cost is £2/unit, selling price is £18/unit, normal production capacity is 10,000 units/month. Last month, the company produced 12,000 units and sold 10,000 units (2,000 went into inventory). The CFO wants to see profit calculated under both absorption and marginal costing — and to understand why the two methods give different answers when production exceeds sales.

   Your goals

   • Calculate the absorption rate: £40,000 / 10,000 normal capacity = £4/unit fixed overhead absorption.
   • Absorption costing P&L: Sales £180,000 − COGS (10,000 × (£6 + £4)) = £100,000 − Variable selling £20,000 − Fixed selling/admin £30,000 = £30,000 profit. (Plus a £8,000 over-absorption credit if production was 12,000 vs capacity 10,000 — depending on policy this is taken to P&L immediately or treated as a balance-sheet item.)
   • Marginal costing P&L: Sales £180,000 − Variable cost (10,000 × £8) = £100,000 contribution − Fixed production £40,000 − Fixed selling/admin £30,000 = £30,000 profit.
   • Now show the difference if production = 12,000 but absorption uses *actual* production not normal: under absorption with 12,000 units of production absorbing the £40,000, rate is £3.33/unit; the 2,000 units in inventory carry £6,667 of fixed overhead, which delays £6,667 of expense. Marginal expenses all £40,000 immediately. Profit difference: ~£6,667 — absorption profit is higher by that amount because the fixed overhead in inventory has not yet been expensed.
   • Make the point: absorption "rewards" producing for inventory (boosting reported profit by holding fixed overhead in stock); marginal does not. This is why managers paid on absorption profit have an incentive to overproduce — and why management accounting often switches to marginal/contribution-based reporting for internal performance management.

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