Marginal costing is more useful for decision making purposes, but absorption costing is needed for financial reporting purposes to comply with accounting standards. In the long run, total profit for company will be the same whichever is used because in the long run, total costs will be the same by either method of accounting. Different accounting conventions merely affect the profit of individual periods.
With marginal costing, contribution varies in direct proportion to the volume of units sold. Profits will increase as sales volume rises, by the amount of extra contribution earned. Since fixed costs expenditure does not alter, marginal costing gives an accurate picture of how a firm’s cash flows and profits are affected by changes in sales volume. With absorption costing, in contrast, there is no clear relationship between profit and sales volume. If sales volumes are same from period to period, marginal costing reports the same profit each period (given no change in prices or cost). In contrast, using absorption costing, profits can vary with volume of production, even when the volume of sales is constant. Using absorption costing there is therefore the possibility of manipulating profit, simply by changing output and inventory levels.
Absorption and Marginal Costing Compared
