Cost

ABSORPTION AND MARGINAL COSTING

STUDENT NOTES

Accountants and managers require financial information for many different purposes. To help make such decisions, costs can be classified in different ways: • direct or indirect (in relation to production – product costs) • fixed, variable or semi-variable (in relation to time – period costs). The difference in the treatment of fixed and variable costs is often crucial in making these decisions. The way fixed and variable costs are treated can give substantially different valuations of stock and hence profits. Dividing costs into product costs or period costs is essential in considering cost elements in absorption and marginal costing. Product costs: • can be identified with a product, e.g. direct wages and direct materials. • can be charged against revenue in the period when the products to which they relate are sold. • form part of the valuation of stock of finished goods and work-inprogress. Period costs are not included in the valuations of stock. • vary with production. Period costs: • are those associated with time as opposed to product, e.g. annual insurance. • can be charged against revenue in the period in which they are incurred. • are usually fixed over a period of time, e.g. annual rent.

ABSORPTION AND MARGINAL COSTING (H)

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ABSORPTION AND MARGINAL COSTING

Advantages of marginal costing • Easy for non-accountants to understand and can be used with standard costing systems. • Can be used in break-even analysis. • Fixed costs are incurred over a period of time. Such costs are not therefore directly related to production and hence are not included in the valuation of stock. • Profits calculations are more realistic because they are related to the time period during which they arise. Fixed costs are not carried forward from one accounting period to the next. Assists when choices have to be made between alternatives, and contribution (selling price – variable costs) is a critical consideration....