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Management Accounting · Alternative cost accounting principles

Absorption Costing vs Marginal Costing: Key Differences for ACCA

Updated 11 October 2026 · Fact-checked

Absorption costing includes fixed production overheads in the cost of each unit, so they sit in inventory until the units are sold. Marginal costing treats fixed production overheads as a period cost, charged in full to the period. Inventory values and profits differ whenever inventory levels change.

Understand Absorption Costing vs Marginal Costing

Every product has variable costs, such as materials, labour and variable overheads. It also has fixed production overheads, such as factory rent. The two methods differ on one point only: what to do with the fixed production overheads.

Absorption costing adds a share of fixed production overheads to each unit using an absorption rate. Units made but not sold carry that fixed cost into closing inventory. The cost moves to the next period, when the units are sold.

Marginal costing values units at variable production cost only. All fixed production overheads are charged against profit in the period they are incurred. Inventory carries no fixed cost.

This changes the profit. If you produce more than you sell, inventory rises. Absorption costing defers some fixed overhead into inventory, so its profit is higher. If you sell more than you produce, inventory falls. Absorption costing releases fixed overhead from opening inventory, so its profit is lower. If inventory does not change, both profits are equal.

The layouts differ too. Marginal costing shows sales less variable costs to give contribution, then deducts fixed costs. Absorption costing shows sales less full production cost to give gross profit, then deducts non-production costs. Selling, distribution and administration costs are not part of inventory value under either method.

Key formulas to remember

Marginal cost per unit
Direct materials + direct labour + variable production overhead
Used to value inventory under marginal costing. Variable selling costs are not included in inventory.
Absorption cost per unit
Marginal production cost + fixed production overhead absorption rate per unit
Used to value inventory under absorption costing. Production costs only.
Fixed overhead absorption rate
Budgeted fixed production overhead ÷ budgeted activity (units or hours)
Based on budgeted, normal activity, not actual output.
Marginal costing profit
Sales − variable costs = contribution; contribution − fixed costs = profit
Variable costs of sales use marginal inventory values. Include variable selling costs, and all fixed costs.
Profit difference
Change in inventory units × fixed overhead absorption rate per unit
Absorption profit − marginal profit. Positive if inventory rises, negative if it falls. Valid when the rate is the same for opening and closing units.

How to solve Absorption Costing vs Marginal Costing questions

Use this method for any question asking you to compute profit under either method, or to explain the difference.

  1. 1Find the change in inventory: opening units + production − sales = closing units.
  2. 2Work out the variable production cost per unit and the fixed overhead absorption rate per unit.
  3. 3For marginal costing, calculate sales revenue, then the variable cost of sales (variable production cost per unit × units sold), plus variable selling costs, to get contribution.
  4. 4Deduct all fixed costs for the period, production and non-production, to get marginal costing profit.
  5. 5For absorption costing, calculate cost of sales using full unit cost, adjusting for opening and closing inventory, then deduct non-production costs.
  6. 6Adjust for over or under absorption if actual overhead differs from the amount absorbed.
  7. 7Check your answer: absorption profit − marginal profit should equal the change in inventory units × fixed overhead per unit.

Quickest way: Calculate marginal profit, then adjust

When to use it: Use when a question gives both methods' inventory data and asks for the profit under the other method, or asks you to select the correct profit figure.

  1. Work out the profit under the method you are given.
  2. Calculate the change in inventory in units.
  3. Multiply by the fixed overhead absorption rate per unit.
  4. If inventory rose, absorption profit is higher than marginal profit. If it fell, absorption profit is lower.
  5. Add or subtract the difference to get the other profit figure.

Common mistakes in Absorption Costing vs Marginal Costing

  • Including fixed production overheads in marginal costing inventory values.

    Students carry over the absorption unit cost without thinking.

    Fix: Under marginal costing, value inventory at variable production cost only. Strip out the fixed overhead rate.

  • Putting the wrong sign on the profit difference.

    Students memorise the formula but not the logic.

    Fix: Ask whether inventory rose or fell. Rising inventory means fixed overhead is deferred, so absorption profit is higher.

  • Including selling and administration costs in inventory valuation.

    Students think absorption costing means absorbing every cost.

    Fix: Only production costs go into inventory under either method. Non-production costs are period costs.

  • Using actual production instead of budgeted activity to calculate the absorption rate.

    The rate looks like a simple division of cost by output.

    Fix: Use budgeted fixed overhead divided by budgeted activity, unless the question says otherwise.

  • Forgetting that variable selling costs are deducted in marginal costing but based on units sold, not produced.

    Students apply all unit costs to production volume.

    Fix: Charge variable selling costs on units sold. Only production costs are applied to units produced.

Worked examples

Example 1

A company budgets to produce and sell 10,000 units a year. Selling price is $20 per unit. Variable production cost is $8 per unit. Budgeted fixed production overhead is $30,000, absorbed on units produced. In the year it produces 10,000 units and sells 8,000. There were no opening inventories. Fixed non-production costs are $10,000. Calculate the profit under absorption costing and marginal costing.

Show the solution
  1. Closing inventory = 0 + 10,000 − 8,000 = 2,000 units.
  2. Fixed overhead absorption rate = $30,000 ÷ 10,000 = $3 per unit.
  3. Absorption cost per unit = $8 + $3 = $11.
  4. Absorption costing: sales = 8,000 × $20 = $160,000.
  5. Cost of sales = 8,000 × $11 = $88,000. Gross profit = $160,000 − $88,000 = $72,000.
  6. Less non-production costs $10,000. Absorption profit = $62,000.
  7. Marginal costing: sales $160,000. Variable cost of sales = 8,000 × $8 = $64,000. Contribution = $96,000.
  8. Less fixed costs $30,000 + $10,000 = $40,000. Marginal profit = $56,000.
  9. Check: difference = $62,000 − $56,000 = $6,000. Inventory change 2,000 × $3 = $6,000.

Answer: Absorption costing profit is $62,000 and marginal costing profit is $56,000. Absorption profit is $6,000 higher because 2,000 units of inventory carry $6,000 of fixed overhead forward.

Example 2

In a period, a company's absorption costing profit was $45,000. Opening inventory was 1,500 units and closing inventory was 900 units. The fixed production overhead absorption rate was $5 per unit in both periods. What was the marginal costing profit? Select: A $42,000 B $48,000 C $52,500 D $37,500

Show the solution
  1. Inventory change = 900 − 1,500 = a fall of 600 units.
  2. Because inventory fell, absorption costing released fixed overhead from opening inventory, so absorption profit is lower than marginal profit.
  3. Profit difference = 600 × $5 = $3,000.
  4. Marginal profit = $45,000 + $3,000 = $48,000.

Answer: B. The marginal costing profit is $48,000.

Exam tips

  • Most questions in Section A are short reconciliations. Learn the quick method so you finish them in about two minutes.
  • Always identify whether inventory rose or fell first. It tells you which profit is higher before you calculate anything.
  • If the exam asks which statement is true, remember that profits are equal when inventory is unchanged, assuming the same unit costs.
  • Read carefully for variable selling costs and fixed non-production costs. They are the usual traps in marginal costing layouts.
  • For number entry questions, round only at the end and check whether the answer should be positive or negative.

Practice questions from Alternative cost accounting principles

Absorption Costing vs Marginal Costing in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Absorption Costing vs Marginal Costing: frequently asked questions

What is the main difference between absorption and marginal costing?

Absorption costing includes fixed production overheads in unit cost and inventory value. Marginal costing charges them in full to the period and values inventory at variable cost only. This creates different profits when inventory changes.

When are absorption and marginal costing profits the same?

They are equal when opening and closing inventory units are the same, so no fixed overhead is deferred or released. This assumes the absorption rate per unit is the same in both periods.

Which method is allowed for financial reporting?

Inventory in published financial statements under IFRS must include production overheads, so absorption costing is used. Marginal costing is mainly used for internal decisions such as pricing and break-even analysis.

How do I prepare a marginal costing income statement?

Start with sales, deduct variable cost of sales and variable selling costs to get contribution, then deduct all fixed costs. The result is profit. Adjust inventory at variable production cost only.