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Differentiation Between Marginal Costing and Absorption Costing Marginal Costing

Marginal costing focuses on variable costs for product costing, treating fixed costs as period costs, while absorption costing includes both fixed and variable costs, affecting inventory valuation. The break-even analysis determines the sales volume at which total revenue equals total costs, relying on fixed costs, variable costs, and contribution margin. Together, these concepts aid in financial planning and decision-making by highlighting the different approaches to cost management and profitability.

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Differentiation Between Marginal Costing and Absorption Costing Marginal Costing

Marginal costing focuses on variable costs for product costing, treating fixed costs as period costs, while absorption costing includes both fixed and variable costs, affecting inventory valuation. The break-even analysis determines the sales volume at which total revenue equals total costs, relying on fixed costs, variable costs, and contribution margin. Together, these concepts aid in financial planning and decision-making by highlighting the different approaches to cost management and profitability.

Uploaded by

shinymascarenhas11
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Differentiation Between Marginal Costing and Absorption Costing

Marginal Costing considers only variable costs when determining the cost of a product. Fixed
costs are treated as period costs and are charged entirely to the profit and loss account. This
method is particularly useful for short-term decision-making as it focuses on contribution, which
is the difference between sales and variable costs. For example, if a product's variable cost is
AED 20, and the selling price is AED 50, the contribution margin is AED 30.

Absorption Costing, on the other hand, includes both fixed and variable costs in the cost of a
product. Fixed costs are allocated to products, affecting inventory valuation and profit
measurement. This approach is more suitable for long-term decisions as it accounts for all costs
involved in production. For instance, if the fixed cost per unit is AED 10, the total cost of the
product under absorption costing would be AED 30 (AED 20 variable + AED 10 fixed).

The primary difference lies in the treatment of fixed costs. Marginal costing views fixed costs as a
lump sum unrelated to production, while absorption costing distributes fixed costs across all
units produced.

Break-Even Analysis

It is a tool used to determine the sales volume at which a business neither earns a profit nor
incurs a loss. At this point, total revenue equals total costs.

The analysis relies on three key components: fixed costs (e.g., rent or salaries), variable costs
(e.g., raw materials or utilities), and the contribution margin, which is the difference between
the selling price per unit and the variable cost per unit.

The break-even point (BEP) in units is calculated as:

BEP = Fixed Costs/ Contribution Margin per Unit

For example, if fixed costs are 10,000, the variable cost per unit is 20, and the selling price per
unit is 50, the contribution margin is 30 (50 - 20). The break-even point is:

BEP = 10,000/ 30 = 333.33 units (rounded off to 334)

Diagram

In a break-even chart, the X-axis represents units sold, while the Y-axis represents revenue and
costs. The total revenue line starts at zero and increases linearly, while the total cost line starts at
the level of fixed costs and rises with variable costs. The intersection of the two lines is the
break-even point, where the business covers all its costs without earning a profit.

Marginal costing and absorption costing differ primarily in their treatment of fixed costs, with
each method serving distinct purposes. Break-even analysis complements these approaches by
helping businesses determine the minimum sales volume required to avoid losses, ensuring
informed financial planning and decision-making.

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