Management Accounting: Absorption Costing vs Marginal Costing

This report explores the differences between absorption costing and marginal costing in management accounting. It discusses the preparation of income statements and the calculation of net profit using these costing techniques. The report also examines the impact of absorption costing and marginal costing on decision-making and profitability.

Management Accounting
Portfolio

Contents
INTRODUCTION...........................................................................................................................3
TASK 2............................................................................................................................................3
Part A......................................................................................................................................3
PART B..................................................................................................................................6
CONCLUSION................................................................................................................................7
REFERENCES................................................................................................................................8

INTRODUCTION
Management accounting is the systematic process of recording, analysing, evaluating and
presenting of useful financial and non-financial information for internal manager so that valuable
decision taken to attain overall gaols (Arroyo, 2012). There are various costing techniques
included in managerial accounting which are used to prepare income statement in order to
determine the net profit for the accounting year.
In this report, different costing methods are used to prepare income statement and detect the
overall net profit margin.
TASK 2
Part A
Absorption costing: Absorption costs are the management system of valuation for all the
costs required to manufacture a certain item, occasionally named absorption costing costs. This
really is the technique used to compensate for internal and external costs, for example direct
equipment, direct labour, rent and health coverage. Cost absorbing is needed for reporting
purposes according to widely agreed accountability standards (GAAP) (Chenhall and Moers,
2015). Unlike the variable costing technique, all costs are applied to finished goods, if either sold
before the end of the term or otherwise. Absorption costs make sure that perhaps the final part of
inventory is accurately accounted for, so because cost involved with this inventory were also
connected to the overall amount of the remaining inventory. More costs of non-sold goods are
also paid for, thus reducing the real expenditures listed on a report of sales during the current
cycle. In comparison with unit variable computations, this results in increased net revenue
measurement. Furthermore, the utilization of absorption expense provides a special scenario
under which it actually raises net profit to make more products that are not consumed at the close
of the year. As fixed cost is spread over all of the items built, the total expenses of the unit
decreases when additional products can be produced. As output increases, thus, net profit
automatically decreases as the fixed cost share of the products produced is reduced.
Income statement under absorption costing for May and June:
May June
£ £ £ £
Sales 300,000*14 4,200,000 280,000*14 3,920,000

Less cost of sales
Opening inventory 0 0
Cost of production 1,450,000
300,000*4,85 1,455,000
Less closing inventory 0
20,000*4,85 97,000
Cost of sales 1,450,000 1,450,000-
97,000
1,358,000
Profit (AC) 4,200,000-
1,450,000 2,750,000
3,920,000-
1,358,000 2,562,000
Marginal costing: The Marginal Cost is really a valuation strategy in which the residual costs,
i.e. variable costs are paid to expense units, whereas the fixed cost becomes entirely omitted
from the expenditure for that duration. Owing to the disparity between fixed cost and variable
expense, prices are subdivided. Similarly, half-variable costs are separated. Prices are based on
marginal costs and marginal contributions (DRURY, 2013). During the assessment of the
products actually completed and work carried out, only differential costs are considered. In the
stock assessment, even so, the variable overheads for production and purchase will not be
included. The estimation of the productivity of organizations and goods is focused on the
marginal costing. The basis for assessment of marginal costs is the essence of costs that creates a
sense of cost performance and has a major impact on the company’s profitability. This is not a
special costing form, such as taking the decision, operation costs and batch costs. However, the
marginal risk is another form of technology used by management for decision-making purposes.
It sets out the framework for the measurement of prices in order to calculate the productivity of
specific goods, procedures and cost centres. Variable costing may not specify a fixed production
unit cost whilst absorption costs do. When measuring net sales on an income statement, the
investment programme would return one lump-sum expense check box with fixed overhead
expenses. At the same time, absorption costing results in two classifications of fixed overhead
cost: the cost of sales and the level of inventory.
Income statement under marginal costing for May and June:
May June
£ £ £ £
Sales 300,000*14 4,200,000 280,000*14 3,920,000
Less cost of sales

Opening inventory 0 0
Cost of production 1,450,000
300,000*3.5 1,050,000
Less closing inventory 0
20,000*3.5 70,000
Marginal cost of sales 1,050,000 1,050,000-
70,000
980,000
Contribution 4,200,000-
1,050,000
3,150,000 3,920,000-
980,000
2,940,000
Less fixed Cost 400,000 400,000
Profit (MC) 3,150,000-
400,000 2,750,000
2,940,000-
400,000 2,540,000
From the above, preparation of income statement it has been stated that net profit from
marginal costing lower than the net profit from absorption costing. Such as in month of May the
net profit remain the same which was 2750000 and in month of June the net profit from marginal
method was 2540000 which was lower than 25620000 received from absorption costing. The
main reason for difference in figure is treatment of variable cost in absorption costing that gets
absorb with the level of production, whereas in marginal costing it remains unaffected. An
essential differentiation is that absorption costs are needed for income accounting requirements
by the relevant accounting systems, so manufacturing overheads are contained in the stock asset.
Increasing sale’s productivity appears to be greater under fixed prices, although the value of
absorption seems to be less (Hiebl, 2014). The income under marginal costs often goes the same
way as the number of revenue. In the case of consumption charges, income is erratic and often
the reverse of sales for month of May and June. The management decision-making, however, is
focused on the commitment in the context of marginal cost. The expenditure term applies to a
marginal cost surplus in revenues.
PART B
TO: Mark & Spencer Management
From: External financial consultant
From the recent year financial statement it has been determined that M&S is capable of
managing the manufacturing expenses and maintaining maximum retail price and market value.
This could be an indicator of success in marketing.

43920 43554 43189 42824
0%
5%
10%
15%
20%
25%
30%
35%
40%
0.37831597838888
8 0.36908444393050
2 0.36908444393050
2 0.35282216482189
0.06268344207436
77 0.05791487188382
34 0.05791487188382
34 0.05775935729087
89
0.00240227327961
713
0.00322820001349
099 0.00322820001349
099 0.00232765986701
893
0.13913729070274
1 0.13123416892305 0.15353958562195 0.11301791067722
3
Mark and Spencer pr ofi tability
gross profit % operating profit% net profit % ROCE%
From the table above, it has been determined that gross profit percentage in 2017 was
0.35%, which remain same in 2018 and year after it increases to 0.36% in 2019 and 0.37% in
2020. This means that the expenses are reduced to some extent in recent time and company in
producing more and more revenue through sales. The percentage of operating profit remains
unchanged in all three years approx. to 0.57% which increase to a good margin in 2020 to 0.62%
as company is making profit on regular basis. The figures of net profit available from the table
shows the positive increment in the NP percentage which states that respective firm is able to
control all its expenses and maintain a good profit margin. In year 2017 and 2018, NP percentage

is 0.23% that increase to 0.32% in 2019, but the same decrease in year 2020 to 0.24% due to
increase of debt in year. From the above graph it has been observed that return on capital
employed was highest in 2018 (15%) which states that the shareholders were getting the
maximum, advantage of the money invested in different stock portfolios of Mark and Spenser.
The interest coverage ratio was the same through following four years 0.6%. Further, this
indicates how much net income a company has gained from each £ 1 turnover. This expenditure
notes that during each accounting period, the final amount includes extra costs that can be
transformed as simply a balance sheet profit. As the actual product contains further spending, the
spending on the annual report is lower when utilizing the absorption costs. In comparison to
financial statements, gross costing is not always permitted, so internal management measures are
limited to do so. By incremental pricing, where the variable cost is applied to the output, while
fixed operational expenditures are included within the absorption costs. Measuring profits within
fixed costs using net revenue (which excludes the added expenditures), while gross benefit
(which often involves related overtime) is used for absorption expenditures. Although debt can
contribute to tax advantages, a disproportionate combination will lead to substantial profitability
risks. The consumption rates take into consideration both fixed expenses and variable factors for
the assessment. Conditional expenses are therefore primarily taken into consideration for
assessment under production expenses. Profit was their difference between the total expense of
sales and income.
CONCLUSION
In the end of report, it is concluded that MA is a detailed process of summarizing crucial
information with the support of different costing techniques which enables manager to make
effective decisions. The benefit of absorption costing is involving fixed operating expenses in
respect to the expense of the goods. As managers take internal marginal price choices, it
becomes negative as compared with variable costs. On the other side, the variable costs, the
output of the next increment unit of a commodity would only contain additional costs.

REFERENCES
Books and journal:
Arroyo, P., 2012. Management accounting change and sustainability: an institutional approach.
Journal of Accounting & Organizational Change. 8(3). pp.286-309.
Chenhall, R. H. and Moers, F., 2015. The role of innovation in the evolution of management
accounting and its integration into management control. Accounting, organizations and
society. 47. pp.1-13.
DRURY, C. M., 2013. Management and cost accounting. Springer.
Hiebl, M. R., 2014. Upper echelons theory in management accounting and control
research. Journal of Management Control. 24(3). pp.223-240.