And the unsold stock is valued at total cost of production
Explain Marginal costing?
Only variable costs of production are allocated to products
and the unsold stock is valued at variable cost of production
Fixed production costs are treated as a cost of the period in which they are incurred
What are some main arguments for absorption costing?
- Since all costs are incurred with a view to create a product for sale, all costs should attach to products until sold.
-In the longer term, fixed overhead costs must be recovered through sales if the business is to survive. Setting the stock value by reference to full costs encourages a pricing policy which covers full cost.
-If fixed costs are treated as period cost (which it is in marginal costing) and there is a low level of sales activity in a period then a low profit or a loss will be recorded. If there is a high level of sales activity there will be a relatively high profit. Absorption costing created a smoothing of these fluctuation by carrying the fixed costs forward until the goods are sold.
What are some arguments for marginal costing?
Useful in decision making:
-In the short term, relevant costs are required for decision making and fixed overheads are largely non-relevant because they can not be avoided. They are best seen as a committed cost of the period.
-Profit calculation is not affected by changes in stock levels.
-Avoids risk of carrying forward in stock an element of fixed overhead cost which may not be recovered through sales.
-In the short term, full-cost pricing may result in loss of sales which would have made a contribution to fixed costs and profit.
-Where sales volumes are declining but output is sustained, marginal costing gives the profit warning more rapidly than does absorption costing.