Cambrige AS and A Level Accounting Notes (9706)/ ZIMSEC  Advanced Accounting Level Notes: Marginal Costing: Introduction

  • We have already looked at absorption costing here
  • Now it is time to examine marginal costing which is an alternative way of looking at things
  • For while absorption costing treats production overheads as a product cost by assigning a share of these overheads to each units produced
  • Marginal costing treats all fixed overheads as period costs which are charged in full against the profit for the period
  • Because of this absorption and marginal costing give different value to inventory and cost of sales sold as the later uses an amount which does not have a portion of fixed costs
  • The marginal cost of a unit of inventory is the total of variable costs required to produce that unit
  • This includes direct materials, direct labour, direct expenses and variable production overheads
  • No fixed overheads are included in the inventory valuation
  • As they are treated as period costs and deducted in full in the profit and loss statement
  • Marginal cost can thus be defined as the cost incurred by producing one extra unit
  • That cost could be avoided if that unit is not produced or procured
  • Even with its apparent flaws marginal costing is a very useful decision making technique
  • This is because marginal costing focuses on avoidable costs that can be changed by the decision under consideration rather than getting distracted by unavoidable fixed overheads


  • At the heart of marginal costing is the concept of contribution
  • \text{Contribution = Sales Price-Variable Costs}
  • Contribution¬†can thus be defined as the amount left over after variable costs have been deducted from the selling price
  • It represents the amount each unit “contributes” towards fixed overheads
  • Unlike the profit of producing each unit contribution per unit is constant in spite of changes in levels of activity
  • \text{Total contribution = Contribution per unit x Sales Volume}
  • \text{Profit= Total Contribution-Fixed Overheads}

The effect of absorption and marginal costing on inventory valuation and profit determination

  • Marginal costing values inventory at the variable cost of production of each product unit
  • Absorption costing on the other hand values inventory at the full production cost of each unit including absorbed portions of fixed overheads
  • Inventory values will therefore be different at the beginning and end of the year under marginal and absorption costing
  • Naturally this means a different profit/loss will be reported in a given period depending on which method is used

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