Income Statements under Marginal and Absorption Costing

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Explanation with Solved Examples:

In  absorption costing technique no difference is made between fixed and variable cost in calculating profits. Absorption costing statement assumes that fixed costs attach to products so all the production costs, whether fixed or variable should become part of product cost.

Marginal cost statement offers an alternative layout to the traditional income statement prepared under absorption costing. Marginal cost statement treats fixed and variable cost separately and shows contribution. However gross profit does not find any place in the marginal costing statement.

Following formats show the difference between the presentation of information in income statements prepared under absorption and marginal costing.

Marginal Costing (Variable Costing) Income Statement – Format:

marginal-costing-income-statement-format

Absorption Costing Income Statement – Format:

absorption-costing-income-statement-format

Formula – Absorption Rate per unit:

Statement to Reconcile Profits under Marginal and Absorption Costing – Format:

statement-to-reconsile-profit-format

Solved Example 1:

A business sells ice cream. Following information are available for the year ended 30 June 2016.

income-statement-data-1

Required:

Prepare income statement for the year ended 30 June 2016 based on both marginal (variable) and absorption costing.

Solution:

Marginal Costing (Variable Costing) Income Statement

For the year ended 30 June 2016

marginal-costing-income-statement-solved-example-1

Absorption Costing Income Statement

For the year ended 30 June 2016

absorption-costing-income-statement-solved-example-1

Solved Example 2:

Topper Plastic makes and sells a single product. In September 2016, it produced and sold 30000 units. Information for September 2016 was:

income-statement-data-2

 

Required:

Prepare income statements for September 2016 by using:

(a) Marginal costing (variable costing); and

(b) Absorption costing

Solution (a):

Marginal (Variable) Costing Income Statement

For the month ended 30 Sep. 2016

 marginal-costing-income-statement-solved-example-2

Solution (b):

Absorption Costing Income Statement

For the month ended 30 Sep. 2016 

absorption-costing-income-statement-solved-example-2

Profits of Marginal (Variable) and Absorption Costing:

Though in the above example profits under both marginal and absorption costing is same; however this is not unusual to see different profits under both techniques. This difference in profits is due to use of different inventory valuation methods under both techniques.

In marginal costing inventories are values at marginal cost of production, but in absorption costing they are valued at total production cost which causes different profit figures in both techniques.

The following points should be considered in this regard:

  • Profit will not differ in the absence of both opening and closing inventories.
  • Profit will not be different if the quantities of both opening and closing inventories are same, provided same fixed cost amount is included in both inventories.
  • When opening inventory is more than closing inventory, the profit under absorption will be less due to inclusion of a relatively higher amount of fixed cost in opening inventory.
  • When opening inventory is less than closing inventory, the profit under absorption costing will be higher due to inclusion of a relatively higher amount of fixed cost in closing inventory.