- We will now demonstrate the difference between marginal and absorption costing using a simple example
Example
Assume that a company produces two products, Product X and Product Y. The following information is available for the period:
Product X:
- Number of units produced: 10,000
- Variable cost per unit: $5
- Fixed cost per unit: $3
- Selling price per unit: $10
Product Y:
- Number of units produced: 20,000
- Variable cost per unit: $3
- Fixed cost per unit: $2
- Selling price per unit: $8
In addition, the company incurs $50,000 of fixed administrative costs for the period. Assume everything that’s made is then sold.
Income Statement using Absorption Costing:
| Product X | Product Y | Total | |
|---|---|---|---|
| Sales Revenue | $100,000 | $160,000 | $260,000 |
| Cost of Goods Sold | |||
| Beginning Inventory | $0 | $0 | $0 |
| Add: Cost of Production | $80,000 | $100,000 | $180,000 |
| Goods Available for Sale | $80,000 | $100,000 | $180,000 |
| Less: Ending Inventory | $0 | $0 | $0 |
| Cost of Goods Sold | ($80,000) | ($100,000) | ($180,000) |
| Gross Profit | $20,000 | $60,000 | $80,000 |
| Selling and Administrative Expenses | ($50,000) | ($50,000) | ($100,000) |
| Net Operating Income | ($30,000) | $10,000 | ($20,000) |
Income Statement using Marginal Costing:
| Product X | Product Y | Total | |
|---|---|---|---|
| Sales Revenue | $100,000 | $160,000 | $260,000 |
| Variable Cost of Goods Sold | ($50,000) | ($60,000) | ($110,000) |
| Contribution Margin | $50,000 | $100,000 | $150,000 |
| Fixed Cost | ($30,000) | ($40,000) | ($70,000) |
| Gross Profit | $20,000 | $60,000 | $80,000 |
| Selling and Administrative Expenses | $50,000 | $50,000 | $100,000 |
| Net Operating Income | ($30,000) | $10,000 | ($20,000) |
Note: In marginal costing, fixed overheads are treated as period costs and are not included in the cost of goods sold.
