MANAGERIAL

ACCOUNTING
MANAGERIAL AND ABSORPTION
COSTING

SUBMITTED TO: MISS MARIAM HINA

SUBMITTED BY: HABIBA KAUSAR
BS-COMMERCE 6TH
2016-B.COM-004
16-MARCH-2019

FATIMA JINNAH WOMEN UNIVERSITY

 MANAGERIAL COSTING AND ABSORPTION COSTING
Introduction:
Business climate is changing rapidly in current scenario therefore management needs every day
and accurate information about the business and costs incurred to take wise decisions to avoid all
possible wastages and losses and to augment the effectiveness of the business. The management
must to make proper assessment of the productivity and performance of the personnel only if it
uses effective costing methods. It is recommended to consider a particular costing method
because costing methods that a business adopts can play vital roles in the development of
advanced manufacturing technologies and business philosophies. 
Marginal costing and absorption costing are the basic two methods of costing that are used for
managerial decision making. Both are types of product costing systems. These two costing
systems are often used in cost accounting, but for different purposes:
 Marginal costing – helps with short-term decision-making
 Absorption costing – is used to calculate inventory valuations and profit calculations in
financial statements
Marginal costing:
Basic idea:
The marginal cost of an item is its variable cost. In marginal cost only variable manufacturing
costs are charged to product cost.
Fixed costs (weather manufacturing or non-manufacturing) are treated as period costs

Total cost

Product period
cost cost
fixed manufacturing
direct material
overhead

variable non-
direct labour
manufacturing overhead

fixed non-manufacturing
direct expenses
overhead

variable manufacturing
overhead
Marginal Costing: Marginal costing principles are used for internal decision making purposes
(short-term). As fixed costs are incurred regardless of the level of activity the purpose of
marginal costing is to determine what contribution is been generated (sales less variable costs).
A marginal costing statement can be prepared in the following format:
£
Sales revenue x
Less Variable costs x
Equals Contribution x
Less Fixed costs x
Equals PROFIT x

A marginal costing statement is of benefit to the managers of a business because:

 contribution, ie selling price less variable cost, is clearly identified
 with the marginal cost of output identified, the managers can focus on the contribution
provided by the output
 the effect on costs of changes in sales revenue can be calculated
 it helps with short-term decision-making in the forms of
– Break-even analysis
– Margin of safety
– target profit
– Contribution sales ratio
– limiting factors
– ‘special order’ pricing
Absorption costing:
Basic idea:
Absorption costing is a method of building up a full product cost which adds direct costs and a
proportion of production overhead costs by means of one or a number of overhead absorption
rates. Absorption coating is also known as full costing
All manufacturing costs (weather variable or fixed) are charged to product cost
Non-manufacturing are treated as period cost
 Total cost

product
period cost
cost

direct material
variable non-
direct labour
manufacturing overhead

fixed non-manufacturing
direct expenses
overhead

variable manufacturing
overhead

fixed manufacturing
overhead

Absorption costing:
Absorption costing principles must be used when preparing financial statements for external
purposes. One of the key principles of absorption costing is that inventory and units produced
must include a share of all production costs, both fixed and variable, incurred in getting them to
their present condition.
Absorption costing income statement
Advantages and disadvantages of absorption and marginal costing:
Advantages of marginal costing
 Contribution per unit is constant
unlike profit per unit which varies
with changes in sales volumes
 There is no under or over
absorption of overheads (and
hence no adjustment is required
in the income statement).
 Fixed costs are a period cost and
are charged in full to the period
under consideration
 Marginal costing is useful in the
decision-making process
 It is simple to operate
Advantages of absorption costing
 Absorption costing includes an
element of fixed overheads in
inventory values (in accordance
with SSAP 9).
 Analyzing under/over
absorption of overheads is a
useful exercise in controlling costs
of an organization
 In small organizations, absorbing
overheads into the costs of
products is the best way of
estimating job costs and profits on
jobs