cost accounting and performance appraisal

Arguments in favor of ABSORPTION COSTING

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1.absorption costing does not understate the importance of fixed cost.
2.fixed overhead are essential for production.
3.closing stock values by including the share of fixed production overhead will be valued on the principles required for financial accounting valuations of stocks.
4.company may not be clear whether contribution by each product is enough to cover fixed costs , whereas by charging fixed overheads to a product it is possible to ascertain whether it is profitable or not.

Arguments in favor of MARGINAL COSTING

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1. marginal costing provides more useful information for decision making .
2.marginal costing removes from profit the effects of inventory changes .
3.it is simple to operate .
4.there are no apportionment which is done on frequently basis, of fixed cost
5.under or over absorption of overheads is avoided.

Difference in profits of marginal and absorption costing

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Marginal and Absorption costing are different techniques for assessing profits in a period.

in case of change of stock during the period both will give different results for profit obtained .

1. if stock level increase absorption costing will report higher profits.
2.if stock level decrease absorption costing will report lower profits.
3.if the opening and closing stock volumes are same , marginal and absorption costing will report same profits.

NOTE : in the long run , total profits for the company will be the same whether marginal or absorption costing is used.

Absorption costing

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in Absorption costing all manufacturing costs , fixed and variable are assigned to units of product units are said to fully absorb manufacturing costs.

This approach is known as Full Cost Approach .

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Marginal Costing:

Marginal costing is also known as Variable casting and Direct costing.

in marginal costing only variable costs are charged as " cost of sales"
and contribution is calculated.
(contribution = sales revenue - variable cost of sales)

closing stock of W.I.P of finished goods are valued at MARGINAL ( variable ) production cost.

fixed costs are treated as period cost , and is charged in full in profit and loss account for the part of the accounting period in which they are incurred.

Marginal and Absorption costing

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To understand this topic we must have to develop concept relating to fixed and variable costs.

Fixed cost: a fixed cost is a cost which tends to be unaffected by the increase or decrease in the volume of output e.g rent and insurance

Variable cost: variable cost is a cost which increase or decrease with the volume of activity. e.g material, labor,sales commision