MARGINAL COSTING/DIRECT COSTING/VARIABLE COSTING
This is a costing technique in which only variable manufacturing costs are considered and used in valuing inventories and also in determining the cost of goods sold i.e. only variable production cost are considered as products cost and are allocated to the products manufactured. These costs include; direct material, direct labour, direct expenses and variable manufacturing overheads.
Fixed manufacturing overheads are not considered as product cost. Instead they are treated as period costs to be written off to the profit and loss account.
ABSORPTION COSTING/FULL COSTING/INDIRECT COSTING
All manufacturing costs (variable and fixed) are considered as cost of production and are used in determining the cost of goods manufactured and the value of inventories. Fixed manufacturing overheads are absorbed into the cost of finished goods.
Differences between marginal costing and absorption costing
Cost elements included in production
They differ in the absorption of fixed production overheads. Selling and administration expenses, whether variable or fixed are treated as period costs and do not form part of product cost. Instead they are charged as expenses in the profit and loss account.
The value of inventories of finished goods under marginal costing is relatively low since inventory values are determined only on the basis of variable production cost. In absorption costing the value of inventories is comparatively high because it includes even fixed manufacturing overheads, as part of the product cost.
The treatment of fixed manufacturing Overheads brings about a difference in net profit figures in the two costing techniques only where there are inventories of finished goods.