Cambrige AS and A Level Accounting Notes (9706)/ ZIMSEC  Advanced Accounting Level Notes: Reconciliation of marginal costing and absorption costing profits

  • Because absorption costing includes the cost of fixed overheads in:
    1. Opening and closing inventory and
    2. Cost of sales
  • There will be inevitable differences in profit figures calculated using the two methods
  • These differences will arise whenever there is an increase or decrease during a period
  • If inventory levels increase, absorption costing will give a higher profit
  • This is because fixed overheads held in closing inventory are carried forward to the next accounting thus reducing the cost of sales instead of being written off in the current period as a period cost as is done under marginal costing
  • If inventory levels decrease marginal costing will give a higher profit
  • This is because fixed overheads brought forward in opening inventory are charged, thereby increasing the cost of sales and reducing profit for the period
  • If inventory levels are constant both methods (absorption and marginal) will give the same profit
  • When the two methods are used and give different profit figures it might be necessary to prepare a reconciliation
  • The aim of this reconciliation is to account for the differences between actual profit obtained using the absorption costing method with the actual profit obtained using the marginal costing method
  • Sometimes in the exam you might be given a profit calculated using one of the methods (say absorption costing) and be asked to calculate the profit that would be obtained using the other corresponding method (for example marginal costing)
  • An example of a reconciliation can be found here

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