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Cost and Management Accounting · Marginal Costing

Absorption vs Marginal Costing and Profit Reconciliation

Updated 4 October 2026 · Fact-checked

Absorption costing includes fixed production overhead in product cost and carries it in stock. Marginal costing treats fixed cost as a period cost and charges it fully to the period. Profit differs only when stock changes. Difference = change in stock units × fixed overhead per unit.

Understand Absorption vs Marginal Costing and Profit Reconciliation

Every product has variable costs and fixed costs. The two methods differ on one question: should fixed production overhead be part of the cost of a unit?

Under absorption costing, yes. Each unit carries a share of fixed production overhead through an absorption rate. Unsold units in closing stock carry that fixed overhead into the next period.

Under marginal costing, no. Only variable costs go into product cost and stock valuation. The whole fixed cost of the period is written off against that period's contribution.

So the stock figures differ. Absorption stock is valued at variable cost plus fixed production overhead per unit. Marginal stock is valued at variable cost only. This is the only source of profit difference.

If production equals sales, there is no change in stock, so profit is the same under both methods. If production is more than sales, stock rises and absorption profit is higher. If production is less than sales, stock falls and marginal profit is higher.

Key rules to remember

Contribution
Contribution = Sales − Variable cost
Marginal costing statement shows contribution first, then deducts total fixed cost.
Marginal costing profit
Profit = Contribution − Fixed cost
Include fixed selling and administration cost here as well.
Absorption costing profit
Profit = Sales − Cost of goods sold (including fixed production overhead) − Selling and administration cost
Adjust for under or over absorption of overhead.
Fixed overhead absorption rate
Rate per unit = Budgeted fixed production overhead ÷ Budgeted output
Use the basis given in the question (normal or budgeted capacity).
Profit difference
Absorption profit − Marginal profit = (Closing stock units − Opening stock units) × Fixed production overhead per unit
If the rate differs between years, use closing stock × current rate − opening stock × previous rate.
Reconciliation rule
Production > Sales: Absorption profit higher. Production < Sales: Marginal profit higher. Production = Sales: equal.
Holds when the fixed overhead rate is the same in both periods.

How to solve Absorption vs Marginal Costing and Profit Reconciliation questions

Use this order for any statement or reconciliation question.

  1. 1Note production, sales, opening stock and closing stock in units. Check stock units: opening + production − sales.
  2. 2Separate costs into variable and fixed. Split fixed into production and non-production (selling, administration).
  3. 3Find the fixed production overhead absorption rate per unit from budgeted figures.
  4. 4Prepare the marginal costing statement: sales, less variable cost of sales (adjusted for stock at variable cost), contribution, less all fixed cost, profit.
  5. 5Prepare the absorption costing statement: production cost including fixed overhead, adjust for stock, add or deduct under or over absorption, then deduct selling and administration cost.
  6. 6Compute the profit difference as change in stock units × fixed production overhead per unit.
  7. 7Reconcile: start with one profit, add or deduct the stock difference, and check it equals the other profit. State the reason in one line.

Quickest way: Stock-change shortcut

When to use it: Use when the question gives one profit and asks for the other, or asks only for reconciliation.

  1. Work out closing stock units less opening stock units.
  2. Multiply by fixed production overhead per unit.
  3. If stock increased, absorption profit = marginal profit + this amount. If stock decreased, absorption profit = marginal profit − this amount.
  4. For MCQs, first test if production equals sales. If so, profits are equal and you can eliminate the options showing a difference.
  5. In written answers, still show both statements or the reconciliation lines, so you earn step marks for format and working.

Common mistakes in Absorption vs Marginal Costing and Profit Reconciliation

  • Including fixed overhead in marginal stock valuation.

    Students value stock at total cost out of habit.

    Fix: Under marginal costing, value stock at variable cost only.

  • Applying the fixed overhead rate to selling and administration cost.

    All fixed costs look alike.

    Fix: Only fixed production overhead enters absorption stock. Selling and administration cost is a period cost in both methods.

  • Getting the direction of difference wrong.

    Students memorise results without logic.

    Fix: Ask where the fixed cost goes. If stock rises, some fixed cost is carried forward, so absorption profit is higher.

  • Ignoring under or over absorption in the absorption statement.

    Actual output differs from the normal capacity used for the rate.

    Fix: Compare overhead absorbed with actual fixed overhead and adjust profit accordingly.

  • Taking closing stock units from the wrong figure.

    Students use production or sales instead of calculating stock.

    Fix: Always compute opening + production − sales first.

Worked examples

Example 1

A company produces and sells one product. Selling price ₹50 per unit; variable cost ₹30 per unit; fixed production overhead ₹40,000 per year, absorbed on normal output of 8,000 units; fixed selling and administration cost ₹20,000. Opening stock nil. Production 8,000 units, sales 7,000 units. Prepare the profit under both methods and reconcile.

Show the solution
  1. Closing stock = 0 + 8,000 − 7,000 = 1,000 units.
  2. Fixed overhead rate = ₹40,000 ÷ 8,000 = ₹5 per unit.
  3. Marginal costing: sales = 7,000 × ₹50 = ₹3,50,000. Variable cost of sales = 7,000 × ₹30 = ₹2,10,000. Contribution = ₹1,40,000.
  4. Marginal profit = ₹1,40,000 − ₹40,000 − ₹20,000 = ₹80,000.
  5. Absorption costing: cost per unit = ₹30 + ₹5 = ₹35. Cost of goods sold = 7,000 × ₹35 = ₹2,45,000. Gross profit = ₹3,50,000 − ₹2,45,000 = ₹1,05,000.
  6. Absorption profit = ₹1,05,000 − ₹20,000 = ₹85,000. There is no under or over absorption, since output equals normal output.
  7. Difference = ₹85,000 − ₹80,000 = ₹5,000. Check: 1,000 units × ₹5 = ₹5,000.
  8. Reconciliation: marginal profit ₹80,000 + fixed overhead in closing stock ₹5,000 = absorption profit ₹85,000.

Answer: Marginal costing profit is ₹80,000 and absorption costing profit is ₹85,000. The ₹5,000 difference is the fixed overhead carried in 1,000 units of closing stock.

Example 2

Using the same data, in the next year production is 7,000 units and sales are 8,000 units. Costs and rates are unchanged except that fixed production overhead is still ₹40,000, absorbed at ₹5 per unit on normal output of 8,000 units. Selling price is ₹50 and variable cost ₹30. Fixed selling and administration cost is ₹20,000. Opening stock is 1,000 units. Find both profits and reconcile.

Show the solution
  1. Closing stock = 1,000 + 7,000 − 8,000 = 0.
  2. Marginal costing: sales = 8,000 × ₹50 = ₹4,00,000. Variable cost = 8,000 × ₹30 = ₹2,40,000. Contribution = ₹1,60,000.
  3. Marginal profit = ₹1,60,000 − ₹40,000 − ₹20,000 = ₹1,00,000.
  4. Absorption costing: cost of goods sold = 8,000 × ₹35 = ₹2,80,000. Opening stock of 1,000 units at ₹35 is included in this, plus production of 7,000 units at ₹35.
  5. Gross profit = ₹4,00,000 − ₹2,80,000 = ₹1,20,000.
  6. Fixed overhead absorbed = 7,000 × ₹5 = ₹35,000. Actual = ₹40,000. Under-absorption = ₹5,000, deducted from profit.
  7. Absorption profit = ₹1,20,000 − ₹5,000 − ₹20,000 = ₹95,000.
  8. Difference = ₹1,00,000 − ₹95,000 = ₹5,000. Check: stock fell by 1,000 units × ₹5 = ₹5,000.

Answer: Marginal costing profit is ₹1,00,000 and absorption costing profit is ₹95,000. Marginal profit is higher by ₹5,000 because opening stock carrying ₹5,000 of fixed overhead was released and charged in this year.

Exam tips

  • Always compute stock units first. Most errors start there.
  • Show the reconciliation even if the question asks only for the profit difference. It earns easy marks.
  • Label under or over absorption clearly in the absorption statement. Examiners look for it.
  • Write one line of reasoning after the reconciliation, such as 'stock increased, so fixed overhead was deferred'.
  • For MCQs, check production versus sales before calculating anything.

Practice questions from Marginal Costing

Absorption vs Marginal Costing and Profit Reconciliation in other exams

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

Absorption vs Marginal Costing and Profit Reconciliation: frequently asked questions

What is the main difference between absorption and marginal costing?

Absorption costing includes fixed production overhead in product cost and stock value. Marginal costing treats all fixed cost as a period cost and values stock at variable cost only. This is why profits differ when stock changes.

When are profits equal under both methods?

Profits are equal when opening and closing stock units are the same, usually when production equals sales. There is no fixed overhead carried forward or released. This assumes the same fixed overhead rate is used.

Does fixed selling cost go into stock under absorption costing?

No. Only production overhead is included in stock value. Selling and administration costs are charged to the period in both methods.

Which method does the cost sheet follow?

A cost sheet normally follows absorption costing. Marginal costing is mainly used for internal decisions, such as pricing and product mix, and for showing contribution.