Answer to Question #151164 in Economics for enny

Question

Comment the 5 reason of why absorption costing is preferable than marginal costing.

Answer 1

The system for calculating the cost of production is known as cost. The main purpose of any costing system is to determine the costs incurred in producing a unit of output. In a manufacturing company, determining the costs associated with a single product is very important in determining the price of the product so that the company can profit and exist in the future. Both costing and marginal costing are the traditional costing system. Both methods have their pros and cons. In modern management accounting, some sophisticated calculation methods are very popular, such as cost by activity (ABC). These methods are created simply by adding and modifying some of the principles of the traditional costing system.

Margin costs

Cost Margin calculates the costs that will be incurred to produce an additional unit. Cost, which includes direct materials, direct labor costs, direct costs, and variable overheads, are the main contributors to margins. The contribution is a concept designed with marginal cost. The contribution is the net sales income in variable costs. When using marginal cost methods, fixed costs are not considered based on the argument that fixed costs such as plant rent, utilities, depreciation, etc., should be incurred regardless of whether production is in progress or not. In marginal calculation, fixed costs are treated as costs for the period. Often, managers require the calculation of marginal costs to make decisions because they include costs that depend on the number of units produced. Margin costs are also known as variable costs and direct costs.

What is the difference between margin and absorption costs?

¤ While marginal cost and absorption cost are two traditional costing methods, they have their own unique principles that draw a fine line between one and the other.

¤ The contribution is calculated in the calculation of the marginal cost, whereas it is not calculated in the calculation of the absorption cost.

¤ Valuation of inventory at marginal cost only considers variable costs, while the valuation of inventory using absorption cost estimate also includes costs incurred for the production function.

¤ Generally, the cost of inventory is higher at absorption cost than at marginal cost.

¤ Margin costs are often used for internal reporting purposes (to facilitate decision-making by managers), while absorption costs are required for external reporting purposes such as income tax reporting.

¤ The contribution should be calculated using the marginal cost system, while the gross profit will be calculated using the absorption cost method.