## Marginal Costing vs Absorption Costing

### Side-by-Side Comparison

Aspect	Marginal Costing	Absorption Costing
Costs included in product cost	Variable costs only	Both fixed and variable costs
Fixed cost treatment	Period cost — charged to P&L immediately	Product cost — absorbed into units produced
Profitability basis	P/V Ratio (Contribution/Sales)	Net profit after fixed cost apportionment
Data presentation	Highlights total contribution of each product	Shows net profit after fixed cost share
Stock/WIP impact on unit cost	Unit cost unchanged regardless of production volume	Unit cost decreases as production increases (fixed cost spread over more units)
Effect of stock change on profit	Opening/closing stock difference does not affect unit cost	Opening/closing stock difference does affect unit cost (fixed cost element carried)

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### When Do Marginal and Absorption Profits Differ?

Rule: The difference in profit arises because fixed overhead is deferred in (or released from) stock under absorption costing.

Stock Situation	Which approach shows more profit?	Reason
No opening/closing stock	Equal	No fixed cost is deferred anywhere
Opening stock = Closing stock (same fixed cost element)	Equal	Fixed cost deferred in equals fixed cost released
Closing stock > Opening stock (Production > Sales)	Absorption Costing	Some fixed overhead is locked in closing stock — not charged to P&L this period
Opening stock > Closing stock (Sales > Production)	Marginal Costing	Old fixed costs from opening stock hit P&L under absorption — adding to current costs

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### Reconciliation Formula

$$\text{Absorption Profit} = \text{Marginal Profit} + \text{Fixed OH in Closing Stock} - \text{Fixed OH in Opening Stock}$$

or equivalently:

$$\text{Difference} = \text{Fixed OH per unit} \times (\text{Closing Stock units} - \text{Opening Stock units})$$

> A positive difference means absorption costing shows higher profit (more stock built up this period).

Worked example

### Example 1

Profit Reconciliation — Production > Sales

Data:

Production: 10,000 units; Sales: 8,000 units
Fixed OH: ₹2,00,000; Fixed OH per unit = ₹20
Closing stock: 2,000 units; Opening stock: 0

Fixed OH in Closing Stock = 2,000 × ₹20 = ₹40,000

Fixed OH in Opening Stock = ₹0

Absorption Profit = Marginal Profit + ₹40,000 − ₹0

Absorption Profit = Marginal Profit + ₹40,000

Absorption costing shows ₹40,000 MORE profit because ₹40,000 of fixed overhead is carried forward in closing stock rather than being charged to this period's P&L.

### Example 2

Profit Reconciliation — Sales > Production

Data:

Production: 6,000 units; Sales: 8,000 units
Opening stock: 2,000 units (carried fixed OH of ₹40,000 from prior period)
Fixed OH this period: ₹1,20,000; Fixed OH per unit = ₹20

Opening stock fixed OH released = ₹40,000

Closing stock fixed OH = ₹0

Absorption Profit = Marginal Profit + ₹0 − ₹40,000

Absorption Profit = Marginal Profit − ₹40,000

Marginal costing shows ₹40,000 MORE profit because absorption costing charges prior period fixed costs (held in opening stock) against current revenues.

⚠️ Common exam mistakes

Saying 'absorption costing always shows higher profit' — this is only true when closing stock > opening stock (production exceeds sales).
Forgetting to reconcile: students often compute both profits separately without linking them through the fixed overhead in stock movement.
Using total fixed OH instead of the fixed OH per unit when calculating the stock adjustment.
Confusing which method 'defers' costs — absorption costing defers fixed OH into stock; marginal costing expenses it all immediately.
Assuming the two methods give the same profit whenever there is stock — they only agree when the fixed cost element in opening and closing stock is identical.

Reference:

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Marginal Costing vs Absorption Costing — Comparison and Profit Differences

Worked example

⚠️ Common exam mistakes