In contrast to this, marginal costing, which is also called variable costing, takes into account only the variable cost as product cost for the calculation of profit. The profit calculation under this method involves two stages, namely contribution and profit. Contribution is the difference between sales proceeds and variable costs. The calculation of contribution is essential in certain types of firms where there are many period costs and also it is necessary to calculate the costs of each product and / or department or process. Once contribution is ascertained, the next step is the computation of profit of the business, which represents the overall profits of all product, department or process, by deducting fixed expenses from the contribution so achieved. If the contribution exceeds the fixed costs, the resultant figure is known as profit. When it is negative, the firm is incurring a loss. There are also chances of both contribution and fixed expenses being the same, such a situation is called no profit no loss point or technically, break-even point.
Under absorption costing, all costs whether fixed or variable are treated as product costs. The cost units are made to bear the burden of full costs even though fixed costs are period costs and have no relevance to current operations. Under the marginal costing technique, however, only variable costs are treated as product costs and the fixed costs are transferred to costing profit and loss account in full to be deducted from the contribution to ascertain profit/loss
Under absorption costing technique, inventories of work-in-progress and finished goods are treated at full costs, while marginal costing values finished and work-in-progress inventory at their variable cost. Naturally, the method of valuation has the effect of carrying over fixed cost to the subsequent period under absorption costing and this will not happen in the case of marginal