Marginal costing and absorption costing

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vikas verma (Querist)
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02 March 2011 Hello everyone

I am a bit confused that whether actual variable factory overheads are used both in marginal costing and absorption costing FOR valuation of closing stock (This confusion has been created by different treatments in module and suggested answers)

can anyone help??????

CA Jeen paul

CA Jeen paul (Expert)
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03 March 2011 yes variable factory overheads are used both in marginal costing and absorption costing as the mariginal costing concerned about the variable element of the production cost and undr absorption costing full cost is considered

vikas verma

vikas verma (Querist)
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03 March 2011 Yes sir I agree with you but actually i want to know that

what to do if both budgeted variable overhead and actual variable overhead are given : whether to use absorbed for poduction cost or to provide under or overrecovery adjustment befor calculating cost of product

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Asha Kanta Sharma

Asha Kanta Sharma

(Expert)
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03 August 2024 Certainly! Understanding the treatment of factory overheads in marginal costing and absorption costing can be tricky, but it's crucial for accurate financial analysis. Here’s a clear breakdown to help clarify:

### **1. Marginal Costing:**

**Definition:**
Marginal costing, also known as variable costing, considers only variable costs for the valuation of inventory and for determining the cost of goods sold. Fixed costs are treated as period costs and are expensed in the period they are incurred.

**Treatment of Overheads:**
- **Variable Factory Overheads:** These are included in the cost of production. For marginal costing, actual variable overheads are used to calculate the cost of the product and the valuation of closing stock.
- **Fixed Factory Overheads:** These are not included in the product cost but are expensed in the period they are incurred.

**Valuation of Closing Stock:**
- Valuation of closing stock is based on the actual variable cost per unit. Fixed overheads do not affect the valuation of closing stock in marginal costing.

### **2. Absorption Costing:**

**Definition:**
Absorption costing allocates both variable and fixed factory overheads to the cost of production. This means that both variable and fixed costs are absorbed into the cost of the product.

**Treatment of Overheads:**
- **Variable Factory Overheads:** Included in the product cost.
- **Fixed Factory Overheads:** Also included in the product cost and absorbed based on the production volume.

**Valuation of Closing Stock:**
- **Budgeted Overheads vs. Actual Overheads:** For absorption costing, the closing stock is valued based on the cost that includes both budgeted variable overheads and fixed overheads.

### **What to Do When Both Budgeted and Actual Overheads Are Given:**

1. **Absorption Costing:**
- If you are using absorption costing, you generally use the budgeted rate for overheads to allocate costs. This is because the product cost includes a share of the fixed overheads based on the budgeted absorption rate.
- At the end of the period, compare the overheads absorbed (based on the budgeted rate) with the actual overheads incurred. The difference is recorded as over-absorption or under-absorption.
- **Adjustments:** The adjustment for over-absorption or under-absorption of fixed overheads is made to the cost of goods sold or is adjusted against the closing stock, depending on how you choose to account for it.

2. **Marginal Costing:**
- In marginal costing, you should use the actual variable overheads for valuation of inventory. The concept of over-absorption or under-absorption is not relevant here as fixed overheads are not included in the product cost.
- The focus is on the actual variable cost incurred, so you don’t adjust for differences between budgeted and actual variable overheads.

### **Summary:**

- **Marginal Costing:** Use actual variable overheads for closing stock valuation. Fixed overheads are expensed in the period incurred.
- **Absorption Costing:** Use budgeted overheads to absorb costs into products. Adjust for any over-absorption or under-absorption at period-end based on the difference between budgeted and actual overheads.

If you are faced with both budgeted and actual overheads, your approach will depend on the costing method you are using. For absorption costing, you focus on the budgeted rate for cost allocation and adjust for differences at period-end. For marginal costing, you only deal with actual variable overheads and do not account for fixed overhead absorption.