Marginal vs Absorption Costing Profit Reconciliation

Understand Marginal Costing vs Absorption Costing Profit Reconciliation

Key rules to remember

Marginal costing income statement

Sales − Variable cost of sales − Variable selling cost = Contribution; Contribution − Total fixed costs = Profit

Variable cost of sales = Opening stock + Variable production cost − Closing stock, all at variable cost. All fixed costs, including production, selling and administration, are charged in full.

Absorption costing income statement

Sales − Cost of goods sold ± Under/over absorption − Selling, distribution and administration costs = Profit

Cost of goods sold = Opening stock + Production cost (variable + absorbed fixed) − Closing stock, at full production cost.

Fixed overhead absorption rate

Rate per unit = Budgeted fixed production overhead ÷ Budgeted (normal) production units

Use units of production, not sales. Under/over absorption = Actual fixed overhead − Absorbed overhead (production units × rate).

Stock valuation rule

Marginal stock value per unit = Variable production cost; Absorption stock value per unit = Variable production cost + Fixed overhead rate

Non-production costs are excluded from stock under both methods.

Profit difference

Absorption profit − Marginal profit = Fixed overhead in closing stock − Fixed overhead in opening stock

If the rate is the same in both periods, this equals (Closing stock units − Opening stock units) × Fixed overhead rate per unit. If the rate differs, value each stock separately.

Direction of the difference

Stock rises: absorption profit higher. Stock falls: absorption profit lower. Stock unchanged in units at the same rate: profits equal.

Use this as a quick check on the sign of your answer.

How to solve Marginal Costing vs Absorption Costing Profit Reconciliation questions

1. 1Write the unit working: Opening stock + Production − Sales = Closing stock. Check it ties with the figures given.
2. 2Compute the fixed overhead absorption rate from budgeted fixed production overhead and budgeted production units. Then compute the variable and full production cost per unit.
3. 3Value opening and closing stock twice: at variable cost for marginal costing, and at variable cost plus the fixed rate for absorption costing.
4. 4Prepare the marginal costing statement. Find variable cost of sales, deduct variable selling cost to get contribution, then deduct all fixed costs to get profit.
5. 5Prepare the absorption costing statement. Find cost of goods sold at full cost, adjust for under or over absorption, then deduct all selling and administration costs.
6. 6Reconcile. Start with marginal profit, add the fixed overhead in closing stock, deduct the fixed overhead in opening stock. The result must equal absorption profit.
7. 7State the reason in one line: stock increased or decreased, so absorption profit is higher or lower by a stated amount.

Quickest way: Reconcile first, then verify with one statement

Common mistakes in Marginal Costing vs Absorption Costing Profit Reconciliation

• Including fixed production overhead in stock under marginal costing

  Students value stock once and use the same figure in both statements.

  Fix: Keep two stock columns. Marginal stock carries only variable production cost. Absorption stock carries variable cost plus fixed overhead.

• Including selling or administration costs in stock valuation

  Students treat every fixed cost like production overhead.

  Fix: Only production overhead goes into stock. Selling, distribution and administration costs are charged to the period under both methods.

• Calculating the absorption rate on sales units

  The rate is confused with a break-even style calculation.

  Fix: Divide budgeted fixed production overhead by budgeted production units. Absorption happens when goods are produced.

• Forgetting under or over absorption in the absorption statement

  Actual production differs from budget, but students use the rate and stop.

  Fix: Compare actual fixed overhead with production units × rate. Add under absorption as a cost, deduct over absorption. Do this whenever actual production differs from the normal level.

• Reversing the sign in the reconciliation

  Students memorise 'add closing, deduct opening' without knowing the starting point.

  Fix: The formula starts from marginal profit. Add closing stock fixed overhead, deduct opening stock fixed overhead. Check against the rule that rising stock gives higher absorption profit.

• Using change in units × rate when the rate changed between years

  The shortcut works only when the rate is the same in both periods.

  Fix: If the rate differs, compute opening stock fixed overhead at last year's rate and closing stock at this year's rate, then take the difference.

Worked examples