The former does not give consideration to fixed costs while the latter adds alls the direct as well as indirect costs to ascertain the total cost of per unit of output. This means that Absorption costing does not make any differentiation between fixed and variable costs whereas Marginal costing accounts for only the variable expenses.
Under this technique the costs are segregated into manufacturing, administrative and selling costs. Here all the manufacturing expenses-fixed as well as variable- are deducted from revenues to obtain gross margin and then the selling & administrative costs-fixed as well as variable- are subtracted from gross margin to obtain the net income. The fixed manufacturing overhead charges are allocated to the units on a per unit basis. This is obtained by dividing “Standard fixed manufacturing overhead” by “Normal Output”.
If the production is higher or less than the standard output, necessary adjustments are done with respect to volume variances. In the case of “favorable volume variance” i.e. if the actual production exceeds normal capacity, the amount relating to over-absorption is subtracted from the cost of goods produced and sold. If the variance is “unfavorable”, the amount relating to under-absorption is added with the total cost of goods produced and sold (Lal & Srivastava, 2008, pp.628).
Under this method a proportion of fixed costs are carried forward to the next accounting period as a constituent of closing inventory. This is criticized by the supporters of marginal costing on the ground that costs relating to an accounting period are transferred to the subsequent period.
Marginal Costing differentiates between variable and fixed costs. The marginal cost refers to the variable cost of a product or it comprises direct material, direct expenses, direct labor and variable portion of the overheads. Marginal Costing is an accounting system under which the variable expenses are charged to the units and the fixed