Cost Accounting: Absorption vs. Marginal

This assignment delves into the concepts of absorption and marginal costing, two key approaches in cost accounting. Students are tasked with analyzing income statements prepared using both methods, illustrating their differences and understanding how these variations influence business decisions. The assignment emphasizes the practical implications of choosing one method over the other, highlighting its relevance in financial reporting and managerial decision-making.

MANAGEMENT
ACCOUNTING

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
TASK 1............................................................................................................................................1
P1) Management accounting and its systems' essential requirement..........................................1
P2) Management accounting reports...........................................................................................3
TASK 2............................................................................................................................................5
P3) Costing and differences between marginal and absorption costing.....................................5
TASK 3............................................................................................................................................9
P4) Critical evaluation on budgetary control systems.................................................................9
P5) Appropriate management accounting systems...................................................................12
CONCLUSION..............................................................................................................................12
REFERENCE.................................................................................................................................14

ILLUSTRATION INDEX
Illustration 1: Income statement through marginal costing method................................................6
Illustration 2: Income statement through absorption costing method..............................................7

INTRODUCTION
Management accounting is multidisciplinary approach that is treated as decision making
tool for managing overall business operations. It includes entire accounting systems as financial,
cost, corporate, inventory and performance therefore growth of organization is possible through
using management accounting tools. The present report is based on understanding different kinds
of planning procedure components to operate business activities of Harrods' Ltd. It is small scale
retail sector organization of UK that provides groceries and food items. Therefore, different tools
and techniques for expansion of organization as well increasing its efficiency can be described.
However, costing as method for price determination of products is to expressed. Including this,
positive and negative aspects of budgetary control system can be presented through this
assignment. Moreover, several financial statements and their analysis role for management of
business operations. Along with this, significance of management accounting for enlargement of
small size organization and its quality services can be expressed through this report.
TASK 1
P1) Management accounting and its systems' essential requirement
Management accounting is system process for making decisions for effectiveness of
organization and improving quality services of entity. It includes several factors as costing,
budgeting, financial and non-monetary performance tools and so on. Therefore, various elements
for forecasting and decision making is obtained by which company's performance can be
enhanced effectively. In addition to this, it is helpful for building up relationship among
employees of the entity (Dellavigna and Pollet, 2013). However, several tools components for
analyzing actual performance and further preparing strategies to improve quality services of
goods and services is presented by management accounting approach. In this process, inventory
get managed efficiently as well remains able for increasing essential for making decisions related
to business operations. Apart from this, costing is done through this process that is useful for
different aspects as production and distribution of products. In this regard, various management
accounting systems for better performance of entity. Therefore, process tools for managing all
business operations are performed that is valuable for development of small scale enterprise and
increasing strength for business and competitive strategies to face competition and sustaining
good position in market. Including this, analyzing customer demand and preparing planning
procedure for proper management and fulfilling their requirements. In accordance to this,
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management accounting is crucial for forecasting and decision making to operate business
activities in systematic developing manner.
Different essential requirements of management accounting systems:- Management
accounting is composition of several systems including financial, cost, inventory and
performance management. Under this system, various processes and tools get enhanced as well
requirements for all accounting systems is needed for effective customer satisfaction. Therefore,
making decisions regarding further business operations is done through this system (Andor,
Mohanty and Toth, 2015). In this regard, management accounting systems and their essential
requirements can be understood as below:-
 Financial accounting:- Management accountant of Harrods' ltd analyses all tools that
presents economic position of organization. On the basis of recognizing these
components, several ideas are created for planning procedure regarding further
implementation. In this process, accounting for monetary performance and improving
profitability is gained. However, calculation for income statement and making decisions
for better quality services are created through this process system. In addition to this, it is
interrelated with productivity and profitability of firm (Zhang, Huang and Zhang, 2015).
Along with this, several tools are presented for increasing profit earning capacity as well
applying tools for effective financial performance through this accounting systems.
 Inventory accounting system:- Management accounting tool includes inventory
management under which goods and services produced by Harrods' Ltd get analyzed. In
accordance to this, it is liable for optimum utilization of resources that affects production
and supplement of products. Moreover, ideas are generated for better quality of goods as
well implementing strategies for increasing creativity in keeping goods safe. However,
analysis of stores including warehouses and business entity is done through this process
that leads to improving inventories of organization in efficient manner (Molenaers and
et.al., 2012). Moreover, inventory accounting is beneficial for adopting innovations as
well supplying goods and services adequately in further year.
 Cost accounting:- Under this process system, cost effectiveness is gained effectively that
is appropriate for determining price of products. However, costing is done through this
process that leads to prepare and analyzing income statement for identifying monetary
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performance of entity. In accordance to this, costing is considered as technique for price
determination and presenting financial performance of organization (Liu and Wu, 2014).
Therefore, making decisions and preparing planning for further business operations is
gained effectively. Thus, cost accounting is beneficial for systematic productivity and
profitability of organization at high level.
 Performance management system:- In this process, management accounting is helpful
for improving working efficiencies of employees. In this regard, it plays important role
for building up good relationship between employees and employer of the company. It is
valuable to encourage all workers for better working performance. In this process,
management accountant of Harrods' Ltd analyses performance of organization and
employees as well further prepares strategy for improvements effectively (Hise and
Strawser, 2013). Thus, performance management is possible through using management
accounting systems for increasing quality services of entity and workers who contribute
in team work.
P2) Management accounting reports
Management accountant of Harrods' Ltd analyses all business performance as well
prepares and maintain report to present financial and non-economic position of small scale
enterprise. In this regard, different kinds of reports are prepared such as financial, cost, inventory
and performance of organization as well employees (Mohammed and Mansor, 2012). In
addition to this, several kinds of reports can be described as below:- Cost accounting report:- Costing technique leads to prepare income statement that
presents financial performance of entity. However, all incurred expenses and gained
revenue are reported and recorded through this process. In accordance to this, proper
balance of production and distribution of goods can be gained. It is beneficial for proper
price determination. Therefore, preparing and maintaining reports related to purchasing
and selling goods are managed by analyzing them as well implementing activities for
further business operations. It is interrelated with production and supplement of goods
and services also impacts on productivity and profitability of firm (Silva and Jayamaha,
2012). Therefore, cost accounting reporting is useful for management of entire business
activities effectively.
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 Inventory management reports:- Under this report system, management accountant of
Harrods' Ltd recognizes inventories as well looks at keeping goods at different places
such as warehouses, stores and business entities. In this process, management of all
inventories is obtained. Including this, proper data is recorded that is helpful for making
decisions related to production and distribution of goods and services (Tosun and
Bağdadioğlu, 2016). Moreover, inventory management reports are useful for optimum
allocation of resources also able to enhance profitability of firm. Hence, excess of goods
and resources get reduced through this system. In addition to this, inventories of
organization get managed efficiently that leads to increase profit earning capability as
well high level of production of goods. Therefore, management accounting tool as
inventory reports are prepared and maintained for organization's effectiveness. Price optimization reports:- Through this process system, management accountant of
Harrods' Ltd prepares strategies to set price of products according to affordability and
earning level of customers. In this regard, several ideas are created for deciding price at
optimum level. Moreover, pricing is interlinked with preparing income statement
(Bierman and Smidt, 2012). According to cost incurred for purchasing raw materials and
production for goods is obtained. Including this, on behalf of market demand,
competition strategy, price of product get fluctuated. In addition to this, price
optimization is helpful for effective production of goods that affects profitability of
organization. Hence, price optimization as management accounting tool is beneficial to
present financial and non-monetary performance of entity at large scale. Ratio analysis:- It is one of the most financial component of management accounting that
presents economic profile of firm. In this process, different kinds of ratios are evaluated
such as liquidity, profitability and debt-solvency ratio. Therefore, overall business
operations are analyzed through these ratios that proceed to implementing strategies
related to enhancing profit earning capability and productivity (Lee, Johnson and Joyce,
2012). However, comparison between last years' performance is created through this
process. Thus, ratio analysis is valuable for effectiveness of small scale enterprise and
improving its efficiencies at high level. In this regard, management of entire business
operations is achieved through this process that affects all organizational functions of
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Harrods' Ltd. In addition to this, it is recognized that by analyzing ratio analysis
effectively, several ideas are created to operate business activities in future time. Variance analysis:- Through this management accounting system, comparison between
actual and expected performance is done that generates different ideas to bridge the gap.
However, proper balance between actual and standard performance can be achieved for
expansion of entity as well carrying on it efficiently (Hillier, 2012). Moreover, analysis of
this variance and determining its favorable and unfavorable aspects is helpful for making
decisions regarding further business operations in systematic manner. In this process,
adequate production and distribution of goods and services produced by organization is
gained. Hence, management accounting method as variance analysis is valuable for
implementing further strategies as well creating innovations in better quality services of
products.
 Budgeting:- It is considered as one of the great forecasting and decision making tool for
further business operations. Under this process system, management accountant of
Harrods' Ltd analyses actual business performance through monetary and non-economic
tools. It includes all business operations as financial, cost, inventories and other
performances. However, on the basis of its critical evaluation, different ideas are created
for better quality services and making decisions for improving them at high level. In this
regard, it is analyzed that budgeting system is helpful for optimum utilization of
resources and fund adequately (Gelman and et.al., 2014). However, overall business
operations get managed through this method that leads to create innovations and carrying
on organization's effectiveness at large scale. Thus, budgeting and budgetary control
system is useful for better quality services and implementing action plans in further years.
TASK 2
P3) Costing and differences between marginal and absorption costing
Costing is considered as a technique for price determination that proceed to prepare
income statement for presenting financial performance of Harrods' Ltd. In this process, several
kinds of methods are used for evaluating price of goods and services to be produced. It is done
through analysing market demand, competition and other aspects (Otley and Emmanuel, 2013).
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However, various methods are applied for costing such as marginal, absorption, activity based
costing and so on. In which, marginal and absorption costing can be understood as follows:-
Marginal costing:- It is costing method that is simplest method for price determination
that is useful for making decisions and creating balance between incurred expenses and gained
revenue. Including this, it is appropriate for short term decision making process also useful for
reducing issues occur at workplace. For determining net profit through this costing method, gross
profit is deducted with cost incurred on variable expenses only (Hise and Strawser, 2013).
Therefore, it is suitable for implementing action plans for short time period effectively. Along
with this, management accountant of Harrods' Ltd evaluates net profit through marginal costing
can be interpreted as below:-
Interpretation:- Harrods' Ltd incurred 6600 on production of groceries and further gains
21000 on selling the items. However, gross profit achieved on this transaction of goods is
calculated as 14400. Further, for calculating net profit through this process, gross profit is
deducted with only variable expanses. In this regard, expenses incurred on production of goods is
interpreted as 1200 while sales expenditure is 600. Therefore, overall variable expenses is
evaluated as 1800. Furthermore, net profit is calculated as 12600. As per this data interpretation,
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Illustration 1: Income statement through marginal costing method

it is analysed that organization has earned effective profit through by producing and
supplementing its goods. Thus, in further years, it will grow at high level as well its profitability
will be enhanced that affects its productivity and profit earning capability. It is recognized that
company's profitability potential is quite good therefore, in future time, by implementing
strategies, it can improve its quality services at large scale.
Absorption costing:-
Interpretation: From the above table 2 the calculation has been done on the basis of
absorption costing method under which both type of expenses are taken in consideration.
Therefore, the cost of goods sold is ascertained by summing up direct material, direct labour,
variable expenses and fixed expenses are to be taken that is 6600. Thereafter the cost of goods
sold 6600 is deducted from the sales revenue 21000 for the purpose of calculating gross profit
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Illustration 2: Income statement through absorption costing method

that is 14400. After that, all the expenses in which it includes variable overhead and total fixed
expenses that are deducted from the gross profit 14400 by calculating net profit of a Company
that is 9300.
From the both table 1 and table 2 it has been interpreted that the marginal net profitability
is more than the absorption costing method. The main reason the difference in the net profit is
that in the marginal costing it only take variable expenses and ignore the fixed expenses.
Whereas, in the absorption costing method in take both fixed and variable expenses due to which
net profit under this method is lower than the marginal costing method.
Comparison of marginal and absorption costing:- In the marginal Costing in which it
is applicable in those expenses that are incurred at the time of producing at the producing each
unit. It can further explained in other words in which the marginal costing is that approach under
which there in increase in the opportunity cost at the time of production of an additional unit.
Whereas, in the absorption costing method in which it includes all the cost are included at the
time of producing the all unit cost. There are various differences among marginal costing and
absorption costing method which are as follows-
 Cost application: In the marginal costing in which it includes only those are change with
the time are variable expenses. Whereas, in the Absorption costing method in which there
is all type of cost are included in it are the variable and fixed expenses.
 Profitability: The profits that are incurred in the marginal costing or there is a
profitability of each sale of individuals that will be shown higher in this method.
Therefore, in the absorption costing method in which the profitability that are incur in
this method are lower than the marginal costing method.
 Measurement- The profitability in the marginal costing method in which adopts the
contribution margin in which there is exclude the applicable cost. Beside this, in the
absorption costing method in which it include only gross profits that are applicable cost
are used under this method.
Apart from this there is an also another difference in which there is absorption costing
method through the applicability of accounting framework for the purpose of financial. Thus,
there is an inclusion of inventory stock. Beside this, in the marginal costing in which it does not
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allow the financial reporting purposes for that reason the usage is restricted to internal
management reports.
TASK 3
P4) Critical evaluation on budgetary control systems
In the budgetary control system can be stated as the manager of a company utilizing the
budgets of a Company for the main purpose of controlling cost and also operations at a financial
year. It can be benefited at the time of controlling marketing activities in the Company and it also
coordinating activities that leads to attain the organizational objectives. It facilitate that helps in
make comparison among the actual facts & figures and planned numbers at the accounting
period. It helps in finding out the variance of a company among the actual and budgeted
expenses. Thus, this can be of two type that are favourable and unfavourable variance. The
advantage of budgetary control system is that it helps the firm to effectively allocating the
resource and managed all the activities of a company. It increase the employee morale as it allow
the employees to participate in a decision making. Furthermore, the another benefits from these
is that it minimize the cost and carry out all the activities in most effective manner. There are
various planning tool of budgetary control which are describe as follows-
Variance analysis- It is that type of planning tool of budgetary control that helps in make
comparison between actual and expected performance is done that generates different ideas
to bridge the gap. However, proper balance between actual and standard performance can be
achieved for expansion of entity as well carrying on it efficiently (Hillier, 2012). Moreover,
analysis of this variance and determining its favourable and unfavourable aspects is helpful
for making decisions regarding further business operations in systematic manner. In this
process, adequate production and distribution of goods and services produced by
organization is gained. Hence, management accounting method as variance analysis is
valuable for implementing further strategies as well creating innovations in better quality
services of products. Thus, there are some advantage and disadvantages of variance analysis
are as follows-
Advantages:
 The main advantages of variance analysis is that it is an remedial action in which the
deviation is determined for the purpose of minimize the risk within the organization.
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 The another benefits from these is that it helps in finding out the relationship among the
various different variances that are disclose in the variance analysis.
 The advantages of variance analysis is that it helps in fixing the responsibility of a person
or individual in the department for separately variance.
 The another benefits of variance analysis is that it finding out the all the inefficient
performance of a company and also describe the frequency of inefficient performance.
 The another benefits from the variance analysis is that it helps the company in controlling
cost
 In the variance analysis there are two type of variance can finding out are favourable and
unfavourable analysis. Under this, the favourable variance helps the Company to finding
out the opportunities and through unfavourable variance helps the firm to finding out the
consequence that are directly reporting to the management.
 In the variance analysis there are two type of variance finding out are controllable and
uncontrollable. Under this, only controllable variance are needs to be into consider for the
purpose of take the further decision.
 The variance analysis is used by the management for the purpose of carry out the work in
proper manner from the top level mangers.
 The action that are taken by the management through the variance analysis that directly
leads to reduce cost.
Disadvantages
 It reduces the morale of employee as it does not allow the employee participation
 It consumer time and energy as it requires a expertise for the purpose of calculating the
variance analysis.
Zero base budgeting- It is another planning tool of a budgetary control in which all the
overhead are to be taken for the new time period for the purpose of calculating the cost on the
basis of actual expenses and it ignore the incremental cost. It is used by the cited Company in
which they finding out the risk and also set out the ways through which the objectives can be
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attain. Thus, it is possible through evaluating the solution from the all alternatives source of
funds. Thereafter, there is needs to setting the priorities and budgeted numbers.
Advantages:
 The main benefits from the zero base budgeting is that it finding out the accuracy which
are against the regular method. Thus, with the help of zero base budgeting is that it relook
each and every cash flow for the purpose of finding out cost of operation. Thus, it shows
the clear picture of cost that against the desired performance.
 The another advantages from this is that it shows the efficiency of resource allocating that
are based upon the actual number as it ignore the historical numbers.
 The zero base budgeting is used by the company in which it helps in finding out the
opportunities and also gives the ways for cost-effective through removing all redundant
activities.
 The another advantages of zero base budgeting is that it improves the coordination as
well as communication within each department of a company. Thus, it also motivating
the employees through involve them in a decision making process.
Disadvantages:
 It require a adequate timing as well as human resource as all the department does not
have a all these.
 It requires trainer for the purpose of trained the manager so, they can able to use zero
base budgeting.
P5) Appropriate management accounting systems
Financial issues occurred in Harrods' Ltd due to imbalanced production and distribution
of goods as well high level of competition. In addition to this, it affects further business
operations and competitive strategies of entity. However, monetary issues of the organisation
can be solved out by using following tools described as:
 Key performance indicators (KPI): In this process, current performance of entity is
analysed according to set target. Therefore, both positive and negative aspects of
organisation is determined. In accordance to this, entire business operations as well
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monetary position is identified that shows potential of firm to face competition and
sustain its market position. Thus, by using KPI, actual performance is recognised by
which further upcoming issues can be solved out as economic stability can achieve
effectively.
 Bench-marking: It is competitive approach in which comparison of Harrods' Ltd is done
with its competitive entities. Thus, varieties of ideas are generated for better quality
services and improving organisation's performance systematically. In addition to this,
market position of entity is gained that leads to operate further business operations and
enhancing its effectiveness to face competition and make place in mark. Hence, bench-
marking is one of the great tool for competitive strategies and making place in market for
long time period.
 Budgetary system: Under this system, all business operations are analysed and further
decisions are made regarding further business activities. It is one of the great tool for
optimum utilization of resources and fund efficiently. Thus, systematic planning
procedure is prepared to be followed on in future time to achieve organisation's
effectiveness and increasing its efficiency in a systematic manner.
 Financial accounting- Financial accounting is the main system of management
accounting system that helps the accounting to respond the financial problem. Thus, it
shows all type of financial information in the financial accountant statement that helps in
understanding the financial position (Management Accounting, 2017). On the basis of
recognizing these components, several ideas are created for planning procedure regarding
further implementation. In this process, accounting for monetary performance and
improving profitability is gained. It shows all the financial transaction that are happen at
the time of selling the products or services to its customers. Thereafter, several tools are
presented for increasing profit earning capacity as well applying tools for effective
financial performance through this accounting systems.
 Transfer pricing- It is that pricing in which there is a transaction across boarder that
requires a transfer pricing. Thus, any kind of movable and immovable goods such a loan,
services and gifts etc are transfer by company across another country. Thus, it helps the
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company to understand the financial problem as it shows the fair and accurate
transaction.
CONCLUSION
Summarizing the whole report it has been concluded that Management accounting is
multidisciplinary approach that is treated as decision making tool for managing overall business
operations. It includes entire accounting systems as financial, cost, corporate, inventory and
performance therefore growth of organization is possible through using management accounting
tools. Furthermore, it has been also analysed that there is at the time of preparing the income
statement through adopting the marginal costing method in which the net profit is higher than
the absorption costing method. Thus, most of the authors has been done study on this in which
they analyse that Absorption costing method is more effective than the marginal costing method.
The main reason behind this is that it include all type of cost such as variable and fixed cost
method that helps the Company to determine the cost in most effective manner. Thereafter it has
been also analysed that the marginal net profitability is more than the absorption costing method.
The main reason the difference in the net profit is that in the marginal costing it only take
variable expenses and ignore the fixed expenses. Whereas, in the absorption costing method in
take both fixed and variable expenses due to which net profit under this method is lower than the
marginal costing method.
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using demographics. The Journal of Finance. 68(1). pp. 237-270.
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Hall/CRC.
Hillier, F.S., 2012. Introduction to operations research. Tata McGraw-Hill Education.
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Otley, D. and Emmanuel, K.M.C., 2013. Readings in accounting for management control.
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apparel industry in Sri Lanka. Journal of Emerging Trends in Economics and
Management Sciences. 3(4). pp. 305-354.
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Tosun, C. and Bağdadioğlu, N., 2016. Evaluating gender responsive budgeting in Turkey.
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Management Accounting. 2017. [online]. Available through:
<http://www.ddegjust.ac.in/studymaterial/mcom/mc-105.pdf>. [Accessed on 6th July
2017].
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