The two concepts of accounting are very vital when it comes to the realization of the ones profit in a given business premise. They enable the manager to come up with the best policy in realizing the best profit for a given sale. They depend on the ability of the sales being on a fixed cost or at some points it can rely on some factors like the case of the absorption costing which is believed to be an absorption that is based on all issues dealing with the manufacturing costs into the issue of the inventory rating.
The various costs that are believed to be associated with the absorption costing are like the case of getting the direct material from maybe from the premise itself or at some points get the direct labor for the purpose of production and maximization of the profits. With adequate number of labors in the firm, it would be surety for the business owner of the ability to make adequate profit for a given period of time. This can also depend on the variable means of production overheads and at some points issues related to the direct expenses can also affects the profit margin aimed at by the manager. Some factors like the fixed means of production overheads can also play a vital role in profit maximization. It is clear that marginal cost on the other hand only absorbs the variable manufacturing into the inventory. Some of the merits of the absorption costing as outlined by business scholars are as follows below:
Advantages of the absorption costing
- It gives the distinctive features of the fixed cost in the product cost. This will enable the manager to know how to maximize on the profit of the business once established. This is sometimes valid in that it is suited for influencing price of the product in question. Normally, the pricing that is based on this kind of the absorption costing checks that all costs are compensated. This will also acts as a means of encouraging the laborers since once the profit margin is realized, then it would be treated like their efforts are not in vain to achieve the business goals and objectives.
- Absorption costing is more advantageous as compared to the marginal costing since it will always give the correct version of the profit calculation. It always deals with the trend at which before one allocates his or her manufacturing costs incurred in any business to that of the products in question without taking consideration whether they are fixed or variable in nature. At some points they are referred to as the full costing. This type of the costing will always show the correct version of the profit calculation as compared to the marginal costing mechanism in a position where production is done to have sales in future. This implies that it deals with the issue of the seasonal sales at some points.
- This kind of the costing is believed to have conforms to accrual and matching accounting conceptions which demands matching costs with taxation for a peculiar accounting period of time. It rates the manufacturing costs as the product costs and this inclusive of the fixed cost and the variable cost.
- It has been discerned for the intention of setting up external reports and for stock valuation aims.
- The fixed and variable costs are normally considered as the product costing and at some points the inventory rating to ensure that there is maximum profit achieved in the business.
- It avoids the classifying of costs into fixed and variable elements. This will give proper distinctions between the two and makes one come up with the appropriate solution when needed.
Problems associated with the Absorption Costing
- One of the major drawbacks of the absorption costing is that, it stressed on total cost that is to say both variables as well as fixed, it is not productive for management to use to make decision, control, and planning.
- Another vital factor that can be rated as a drawback of the absorption costing is the case like the issue of the manager emphasizing on the total cost, the cost volume profit relationship is ignored. The manager in this case would be wise to use his or her own knowledge and experience in making vital decisions.
- In the case of this costing, the collection of data could not be the best way of making decision due to the precision matters. They may not be correct data collected and at times they are prone to error during the collection by the researcher.
- The idea of carrying the fixed cost closing stock to another year is not a good idea and this can tremendously affect the profit maximization in a business. This also implies that the fixed cost is not charged against the revenue of the given year of study and this is believed not to be a sound practice in business.
- The concept of the fixed cost normally eliminates the idea of process allocation overheads and more specifically eliminates the idea of allocating and absorbing overheads.
Some of the common features of the marginal cost are like the case of the follow:
- All the elements of the costs are classified into the category of fixed and some as variable costs.
- It is a technique or mechanism of controlling the cost and making decision where applicable.
- It is known that the variable costs are charged as the cost of the production
- Some of the valuable calculation that are done are like the case of the profit calculation in which it is calculated by deducting the fixed cost from the total contribution as gotten from the total selling.
- It is also clear that the profitability level is determined by cost volume profit analysis technique.
In calculating the marginal cost, the formula as shown below is applied to come up with the solution for a given problem.
Marginal cost= variable cost=direct cost + direct material + direct expenses + variable overheads
Merits of the Marginal Costing
- This type of the costing has some merits factors like the case of having constant variable per unit of the type of output achieved within a short period of time. This makes the ability of controlling the cost becoming more effective and simpler to the manager in charge. This type of the costing recognizes the difference between fixed and variable costs hence allowing for applicable information about costs for decision making purposes. When fixed and variable costs are separated, it is believed to be becoming easier to handle costs as it gets clearer to direction on how costs behave. So, by changing the action level, for example, management is able to choose an optimal production level.
- It normally brings out clearly the contribution and at some points the profit making with reference to the unit per the output. This will clearly give the effect needed in the profit. It removes the impression of inventory varies on profit margin and cuts down the danger of nonadaptive behavior in employees within the firm which could hinder proper production.
Dysfunctional behavior may happen in the case of absorption costing by advocating managers to give rise to more inventory than can be sold. Developing for stock has the impression of absorbing more fixed production overheads, hence cutting down the cost of sale. This kind of the reduced cost of sale has the result of mending the level of reported profits. However, it is potential for such stock to tie up capital and even become disused.
Demerits of the marginal costing
- The mechanism is pegged on the issue of the segregation of the costs into the fixed and at some points variable costs and this makes the issue of classifying the costs or expenses as fixed or variable hence becoming difficult to deal with.
- It is also believed that the presumption that relates to the behavior of the cost which is taken as fixed remains the same without any change.
Reference
Difference between Absorption costing and marginal costing http://www.mohanmekap.com/2012/02/difference-between-absorption-costing.html
Comparison between Absorption costing and marginal costing; http://cost-edu.blogspot.com/p/basic-cost-concepts.html
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