Management and Cost Accounting - Unit 4th

 

Marginal Costing

1. Meaning of Marginal Costing

Marginal costing is a technique of cost accounting in which only variable costs are charged to the cost of production, while fixed costs are treated as period costs and are charged fully to the Profit and Loss Account.

In simple words, marginal costing helps a business understand how profit changes when the number of units produced or sold changes.

Definition: Marginal costing is the ascertainment of marginal cost and the effect on profit of changes in volume or type of output by differentiating between fixed costs and variable costs.

2. Meaning of Marginal Cost

Marginal cost refers to the additional cost incurred by producing one extra unit of a product.

Formula:

$$MC=\frac{\text{Change in Total Cost}}{\text{Change in Output}}$$

Example:

If the total cost of producing 100 units is ₹10,000 and the total cost of producing 110 units is ₹11,000:

$$MC=\frac{11000-10000}{110-100}$$

$$MC=\text{₹}100$$

Therefore, the marginal cost per additional unit is ₹100.

3. Characteristics of Marginal Costing

The main features are:

1. Separation of costs: Costs are divided into fixed and variable costs.

2. Variable costing: Only variable costs are charged to products.

3. Fixed costs: Fixed costs are treated as period costs.

4. Contribution: It focuses on contribution, which is the difference between sales and variable costs.

5. Profit determination: Profit is calculated after deducting fixed costs from contribution.

6. Decision-making: It helps management take important business decisions.

7. Inventory valuation: Closing stock is valued at variable production cost.

4. Important Elements of Marginal Costing

A. Fixed Cost

Fixed costs are costs that remain constant in total irrespective of changes in production volume within a relevant range.

Examples:

• Factory rent.

• Salary of permanent employees.

• Insurance.

• Depreciation of machinery.

• Office rent.

Example: If factory rent is ₹20,000 per month, it remains ₹20,000 whether the company produces 100 units or 1,000 units.

B. Variable Cost

Variable costs are costs that change directly with the level of production.

Examples:

• Raw materials.

• Direct wages (when paid per unit).

• Packing expenses.

• Direct expenses.

Example: If the variable cost per unit is ₹50:

Production	Total Variable Cost
100 units	₹5,000
200 units	₹10,000
300 units	₹15,000

C. Semi-Variable Cost

Semi-variable costs contain both fixed and variable elements.

Examples:

• Electricity bills.

• Telephone bills.

• Repair and maintenance expenses.

D. Contribution

Contribution is the amount remaining after deducting variable costs from sales revenue.

Formula:

$$Contribution=Sales-VariableCost$$

Example:

• Sales = ₹1,00,000

• Variable cost = ₹60,000

Contribution = ₹1,00,000 − ₹60,000 = ₹40,000.

Contribution is used to recover fixed costs and earn profit.

5. Important Formulas of Marginal Costing

These formulas are very important for BBA examinations.

Particulars	Formula
Marginal Cost	Variable Cost per Unit
Contribution	Sales − Variable Cost
Profit	Contribution − Fixed Cost
P/V Ratio	(Contribution ÷ Sales) × 100
Fixed Cost	Contribution − Profit
Sales	Variable Cost + Contribution
BEP (Units)	Fixed Cost ÷ Contribution per Unit
BEP (Sales)	Fixed Cost ÷ P/V Ratio
Margin of Safety	Actual Sales − Break-Even Sales
MOS Ratio	(MOS ÷ Actual Sales) × 100
Profit	Sales × P/V Ratio − Fixed Cost
Sales for Desired Profit	(Fixed Cost + Desired Profit) ÷ P/V Ratio

Note: Use P/V ratio in decimal form when calculating sales.

6. Marginal Costing Income Statement

Under marginal costing, the income statement is prepared as follows:

Particulars	Amount
Sales	XXXXX
Less: Variable Cost	XXXXX
Contribution	XXXXX
Less: Fixed Cost	XXXXX
Net Profit	XXXXX

Numerical Example

A company provides the following information:

• Selling price per unit = ₹100

• Variable cost per unit = ₹60

• Fixed cost = ₹10,000

• Units sold = 500

Solution:

Particulars	Amount
Sales (500 × ₹100)	₹50,000
Less: Variable Cost (500 × ₹60)	₹30,000
Contribution	₹20,000
Less: Fixed Cost	₹10,000
Net Profit	₹10,000

Therefore, the net profit is ₹10,000.

7. Applications of Marginal Costing

Marginal costing is useful in various management decisions.

1. Make or Buy Decision

It helps management decide whether to manufacture a product internally or purchase it from outside suppliers.

The company compares the relevant cost of manufacturing with the purchase price.

2. Fixation of Selling Price

Marginal costing helps determine the minimum price at which a product can be sold in special situations.

3. Product Mix Decision

It helps decide which products should be produced and sold to maximise total contribution, particularly when resources are limited.

4. Accept or Reject Special Orders

It helps determine whether a special order should be accepted at a price lower than the normal selling price, provided relevant costs and capacity are considered.

5. Closing Down or Continuing Business

It helps management decide whether a department or product line should be discontinued or continued.

6. Selection of Profitable Products

It helps identify products that generate higher contributions.

8. Advantages of Marginal Costing

1. Easy to understand and operate.

2. Helps in managerial decision-making.

3. Useful in profit planning.

4. Helps in calculating break-even point.

5. Helps in cost control.

6. Useful for determining selling prices.

7. Helps compare the profitability of products.

8. Helps management prepare flexible budgets.

9. Eliminates the problem of arbitrary allocation of fixed production overheads to units for marginal-cost inventory valuation.

9. Disadvantages of Marginal Costing

1. Separation of fixed and variable costs can be difficult.

2. It assumes that variable cost per unit remains constant within the relevant range.

3. It assumes fixed costs remain constant within the relevant range.

4. It is less suitable for long-term pricing decisions when all costs must be recovered.

5. It may ignore the importance of fixed costs in certain decisions.

6. It is difficult to apply where products have complex production processes.

7. It is not a substitute for financial accounting.

10. Difference Between Marginal Costing and Absorption Costing

Basis	Marginal Costing	Absorption Costing
Meaning	Only variable production costs are charged to products	Both fixed and variable production costs are charged to products
Fixed Cost	Treated as period cost	Included in product cost
Variable Cost	Included in product cost	Included in product cost
Stock Valuation	At variable production cost	At full production cost
Profit	Depends mainly on sales volume	Can be affected by production and sales volume
Use	Management decisions	Financial reporting and inventory valuation

11. Break-Even Point (BEP)

Meaning of Break-Even Point (BEP)

Break-Even Point (BEP) is the point at which the total sales revenue of a business is equal to its total cost.

At this point, the business earns neither profit nor loss.

In simple words, BEP tells us how many units a business must sell or how much sales revenue it must generate to cover all its costs.

Definition:

Break-Even Point is the level of production or sales at which total revenue is equal to total cost, resulting in zero profit and zero loss.

At this point, the business earns neither profit nor loss.

$$TotalSales=TotalCost$$

Formula of BEP

In units:

$$BEP=\frac{FixedCost}{ContributionperUnit}$$

In sales value:

$$BEP=\frac{FixedCost}{P\mathrm{/}VRatio}$$

Example

Suppose:

• Selling price per unit = ₹100

• Variable cost per unit = ₹60

• Fixed cost = ₹20,000

Step 1: Calculate contribution.

$$100-60=\text{₹}40$$

Step 2: Calculate BEP in units.

$$BEP=\frac{20000}{40}=500Units$$

Therefore, the company must sell 500 units to avoid loss.

12. Objectives of Break-Even Analysis

The main objectives of break-even analysis are:

1. To determine the minimum sales required to avoid losses.

2. To calculate the level of production required to cover total costs.

3. To estimate the profit or loss at different sales levels.

4. To help management in fixing selling prices.

5. To support business planning and decision-making.

6. To determine the margin of safety.

7. To study the relationship between cost, volume and profit.

8. To help management control business costs.

Types of Break-Even Analysis

A. Cash Break-Even Point

Cash break-even point is the level of sales at which cash revenue equals cash expenses.

It excludes non-cash expenses such as depreciation from fixed costs.

$$CashBEP=\frac{CashFixedCost}{ContributionperUnit}$$

B. Accounting Break-Even Point

Accounting break-even point is the level of sales at which accounting profit is zero after considering all accounting costs, including depreciation.

C. Economic Break-Even Point

Economic break-even point considers both accounting costs and opportunity costs. It is the point at which the business earns a normal economic return.

13. Factors Affecting Break-Even Point

1. Fixed Cost

When fixed cost increases, the break-even point increases.

When fixed cost decreases, the break-even point decreases.

2. Selling Price

When selling price increases and variable cost remains constant, contribution increases and BEP decreases.

When selling price decreases, BEP increases.

3. Variable Cost

When variable cost increases, contribution decreases and BEP increases.

When variable cost decreases, contribution increases and BEP decreases.

4. Product Mix

For a business selling multiple products, changes in the sales mix can affect the overall contribution and break-even point.

5. Production Efficiency

Improved production efficiency may reduce variable cost per unit and lower the break-even point.

14. Advantages of Break-Even Analysis

1. Profit planning: Helps management estimate profit at different sales levels.

2. Cost control: Helps identify the relationship between fixed and variable costs.

3. Pricing decisions: Helps determine the minimum sales level required to cover costs.

4. Business planning: Helps management plan production and sales.

5. Risk analysis: Helps understand the risk of business losses.

6. Margin of safety: Helps measure the safety level of sales.

7. Decision-making: Supports decisions about production and business operations.

8. Performance measurement: Helps evaluate the financial performance of a business.

15. Disadvantages of Break-Even Analysis

1. It assumes selling price per unit remains constant.

2. It assumes variable cost per unit remains constant.

3. It assumes fixed cost remains constant within a relevant range.

4. It may be difficult to classify costs accurately.

5. It assumes production and sales are equal or inventory changes are ignored.

6. It is less accurate when a business sells many products with different contribution margins.

7. It does not directly consider changes in market demand.

8. It is mainly useful for short-term planning under specified assumptions.

15. Assumptions of Break-Even Analysis

The main assumptions are:

1. Costs can be divided into fixed and variable costs.

2. Selling price per unit remains constant.

3. Variable cost per unit remains constant.

4. Total fixed cost remains constant within the relevant range.

5. Production and sales volume are assumed to be equal.

6. Production efficiency remains unchanged.

7. In a multi-product business, sales mix remains constant.

8. The analysis is conducted within a relevant range of activity.

15. Applications of Break-Even Analysis

Break-even analysis is used in different business situations.

• Starting a new business: Helps calculate the sales required to cover costs.

• Launching a new product: Helps estimate the minimum sales required.

• Changing selling prices: Helps analyse the impact of price changes.

• Increasing production: Helps estimate the effect of production volume on profit.

• Cost reduction: Helps understand how cost savings affect BEP.

• Business expansion: Helps estimate the sales needed to cover additional fixed expenses.

• Profit planning: Helps determine the sales required to achieve target profit.

16. Difference Between Break-Even Point and Margin of Safety

Basis	Break-Even Point	Margin of Safety
Meaning	Point where there is no profit and no loss	Difference between actual sales and BEP sales
Purpose	Determines minimum sales to cover costs	Measures the safety level of sales
Calculation	Fixed Cost ÷ P/V Ratio	Actual Sales − BEP Sales
Value	A sales or production level	An amount or percentage
Interpretation	Shows the no-profit, no-loss point	Higher MOS generally means lower risk of loss

17. Difference Between Break-Even Point and Profit Point

Basis	Break-Even Point	Profit Point
Meaning	Total revenue equals total cost	Revenue exceeds total cost
Profit	Zero	Positive
Sales	Equal to BEP sales	Greater than BEP sales
Contribution	Equal to fixed cost	Greater than fixed cost
Result	No profit and no loss	Business earns profit

18. Profit-Volume Ratio (P/V Ratio)

P/V ratio shows the relationship between contribution and sales. It indicates how much contribution is earned from every rupee of sales.

Formula:

$$P\mathrm{/}VRatio=\frac{Contribution}{Sales}\times 100$$

Example:

Sales = ₹1,00,000

Variable cost = ₹60,000

Contribution = ₹40,000

$$P\mathrm{/}VRatio=\frac{40000}{100000}\times 100$$

$$=40\mathrm{\%}$$

Importance of P/V Ratio:

• Helps calculate break-even sales.

• Helps calculate profit at different sales levels.

• Helps compare profitability of different products.

• Helps determine the sales required to earn a desired profit.

19. Margin of Safety (MOS)

Margin of safety refers to the difference between actual sales and break-even sales.

It indicates how much sales can decrease before the business starts suffering losses.

Formula:

$$MOS=ActualSales-BEPSales$$

Example:

• Actual sales = ₹1,00,000

• Break-even sales = ₹60,000

$$MOS=100000-60000=\text{₹}40,000$$

A higher margin of safety indicates a lower risk of incurring losses.

20. Cost-Volume-Profit (CVP) Analysis

CVP analysis studies the relationship between cost, sales volume and profit.

It helps management understand how changes in selling price, variable cost, fixed cost and sales volume affect profit.

Main elements:

• Selling price.

• Sales volume.

• Fixed cost.

• Variable cost.

• Contribution.

• Profit.

Assumptions of CVP Analysis

1. Selling price per unit remains constant.

2. Variable cost per unit remains constant.

3. Total fixed cost remains constant within the relevant range.

4. Production and sales are assumed to be equal, or inventory changes are ignored.

5. Costs can be divided into fixed and variable categories.

6. In a multi-product business, sales mix remains constant.

21. Key Assumptions of Marginal Costing

• Costs can be classified into fixed and variable costs.

• Variable cost per unit remains constant.

• Fixed cost remains constant in total within the relevant range.

• Selling price per unit remains unchanged.

• Efficiency and productivity remain stable.

• The relevant range of activity is known.

22. Important Short Questions and Answers for BBA Exams

Q1. What is marginal costing?

Marginal costing is a costing technique in which only variable costs are charged to products and fixed costs are treated as period costs.

Q2. What is contribution?

Contribution is the difference between sales revenue and variable cost.

Q3. What is break-even point?

It is the point where total sales revenue equals total cost and there is no profit or loss.

Q4. What is P/V ratio?

It is the ratio of contribution to sales expressed as a percentage.

Q5. What is margin of safety?

It is the difference between actual sales and break-even sales.

Q6. What is fixed cost?

Fixed cost is a cost that remains constant in total irrespective of changes in production within a relevant range.

Q7. What is variable cost?

Variable cost is a cost that changes in total according to the level of production.

Q8. What is semi-variable cost?

It is a cost that contains both fixed and variable elements.

Q9. What is the main objective of marginal costing?

Its main objective is to help management in planning, controlling costs and making business decisions.

Q10. What is the difference between contribution and profit?

Contribution is sales minus variable costs, whereas profit is contribution minus fixed costs.

23. Important Numerical Questions for Practice

Try solving these questions for your BBA examination.

Practice questions

0/5 solved

Q1. Selling price is ₹200, variable cost is ₹120 and fixed cost is ₹40,000. Calculate contribution per unit.

Q2. Sales are ₹2,00,000 and variable costs are ₹1,20,000. Calculate P/V ratio.

Q3. Fixed cost is ₹50,000 and contribution per unit is ₹25. Calculate BEP in units.

Q4. Actual sales are ₹5,00,000 and break-even sales are ₹3,00,000. Calculate margin of safety.

Q5. Contribution is ₹80,000 and fixed cost is ₹50,000. Calculate profit.

 

Prepare these topics carefully:

Topic	Importance
Meaning and features of marginal costing	Very important
Fixed, variable and semi-variable costs	Very important
Contribution	Very important
Break-even analysis	Very important
P/V ratio	Very important
Margin of safety	Very important
Marginal vs absorption costing	Important
Advantages and disadvantages	Important
Applications of marginal costing	Important
CVP analysis 1. Meaning of Absorption Costing Absorption costing is a method of costing in which all costs related to production are charged to the cost of a product, including both fixed and variable production costs. It means that the total cost of producing a product includes: Direct material Direct labour Direct expenses Variable factory overhead Fixed factory overhead Under this method, both fixed and variable manufacturing costs are absorbed into the cost of each unit produced. Definition: Absorption costing is a costing technique in which all manufacturing costs, whether fixed or variable, are charged to the cost of products. Example Suppose a company manufactures 1,000 units. Particulars Amount Direct Material ₹20,000 Direct Labour ₹10,000 Variable Factory Overhead ₹5,000 Fixed Factory Overhead ₹15,000 Total Production Cost ₹50,000 Cost per unit: $$=\frac{50,000}{1,000}$$ $$=\text{₹}50$$ Therefore, the absorption cost per unit is ₹50. 2. Objectives of Absorption Costing The main objectives are: To calculate the total cost of production. To include all manufacturing costs in product cost. To determine the cost per unit. To calculate the value of closing stock. To determine the selling price of products. To calculate the profit or loss of a business. To help in financial reporting. To ensure that fixed factory overhead is included in production cost. 3. Characteristics of Absorption Costing The important characteristics are: Complete costing: Both fixed and variable manufacturing costs are included. Fixed overhead: Fixed factory overhead is treated as a product cost. Variable overhead: Variable factory overhead is also included in product cost. Stock valuation: Closing stock is valued at full production cost. Cost per unit: Total production cost is divided by total units produced. Profit calculation: Profit depends on both production and sales when inventory levels change. Financial reporting: It is generally used for external financial reporting under applicable accounting standards. Overhead absorption: Factory overheads are allocated or apportioned and absorbed into products. 4. Elements of Absorption Costing There are five main elements of absorption costing. A. Direct Material Direct material refers to the raw materials that are directly used in manufacturing a product. Examples: Wood used in furniture. Cotton used in textile production. Steel used in machinery. Flour used in bread production. B. Direct Labour Direct labour refers to the wages paid to workers who are directly involved in manufacturing products. Examples: Wages of machine operators. Salary of production workers. Wages of assembly-line workers. C. Direct Expenses Direct expenses are expenses that can be directly identified with a specific product or job. Examples: Royalty paid per unit produced. Special equipment hire for a particular job. Special design charges for a particular product. D. Variable Factory Overhead These expenses change according to the level of production. Examples: Indirect materials. Indirect wages that vary with output. Power consumed by production machinery. Consumable factory supplies. E. Fixed Factory Overhead These expenses remain constant in total within a relevant range, regardless of production volume. Examples: Factory rent. Factory insurance. Depreciation of factory machinery. Salary of factory supervisors. 5. Classification of Costs Under Absorption Costing Type of Cost Treatment Direct Material Product Cost Direct Labour Product Cost Direct Expenses Product Cost Variable Factory Overhead Product Cost Fixed Factory Overhead Product Cost Office Administration Expenses Period Cost Selling Expenses Period Cost Distribution Expenses Period Cost Important: Absorption costing includes all manufacturing costs in product cost, but non-manufacturing costs such as selling and administrative expenses are generally charged to the period in which they are incurred. 6. Formula of Absorption Costing A. Total Production Cost $$\begin{array}{rl}{\displaystyle TotalProductionCost=}& {\displaystyle DirectMaterial}\\ {\displaystyle }& {\displaystyle +DirectLabour}\\ {\displaystyle }& {\displaystyle +DirectExpenses}\\ {\displaystyle }& {\displaystyle +VariableFactoryOverhead}\\ {\displaystyle }& {\displaystyle +FixedFactoryOverhead}\end{array}$$ B. Cost Per Unit $$CostPerUnit=\frac{TotalProductionCost}{UnitsProduced}$$ C. Fixed Overhead Absorption Rate $$FOAR=\frac{TotalFixedFactoryOverhead}{TotalActivity}$$ Activity may be measured in units, labour hours or machine hours. D. Total Cost $$TotalCost=ProductionCost+Non\text{-}ProductionExpenses$$ E. Profit $$Profit=Sales-TotalExpenses$$ 7. Steps Involved in Absorption Costing The following steps are followed: Identification of costs Identify all direct and indirect production costs. Classification of costs Divide costs into direct material, direct labour, direct expenses and overheads. Allocation of overheads Allocate overheads directly to the relevant departments wherever possible. Apportionment of overheads Distribute common overheads among different departments using suitable bases. Absorption of overheads Charge factory overheads to products using an appropriate absorption rate. Calculation of total production cost Add all manufacturing costs. Calculation of cost per unit Divide total production cost by units produced. 8. Overhead Absorption Rate Overhead absorption means charging indirect production costs to products or jobs. Methods of Overhead Absorption 1. Direct Material Cost Method $$Rate=\frac{FactoryOverhead}{DirectMaterialCost}\times 100$$ 2. Direct Labour Cost Method $$Rate=\frac{FactoryOverhead}{DirectLabourCost}\times 100$$ 3. Direct Labour Hour Rate $$Rate=\frac{FactoryOverhead}{DirectLabourHours}$$ 4. Machine Hour Rate $$Rate=\frac{FactoryOverhead}{MachineHours}$$ 5. Percentage of Prime Cost $$Rate=\frac{FactoryOverhead}{PrimeCost}\times 100$$ These methods help businesses distribute indirect manufacturing expenses fairly among products. 9. Numerical Example of Absorption Costing A company produces 2,000 units during a month. The following information is available: Particulars Amount Direct Material ₹40,000 Direct Labour ₹20,000 Direct Expenses ₹10,000 Variable Factory Overhead ₹15,000 Fixed Factory Overhead ₹25,000 Calculate the total production cost and cost per unit. Solution: Particulars Amount Direct Material ₹40,000 Direct Labour ₹20,000 Direct Expenses ₹10,000 Variable Factory Overhead ₹15,000 Fixed Factory Overhead ₹25,000 Total Production Cost ₹1,10,000 Cost per unit: $$=\frac{1,10,000}{2,000}$$ $$=\boxed{{\displaystyle \text{₹}55}}$$ Final Answer Total production cost = ₹1,10,000 Cost per unit = ₹55 10. Preparation of Cost Sheet Under Absorption Costing A cost sheet shows the total cost incurred in manufacturing and selling products. Particulars Amount Direct Material XXXXX Direct Labour XXXXX Direct Expenses XXXXX Prime Cost XXXXX Add: Factory Overheads XXXXX Works Cost XXXXX Add: Office Administration Overheads XXXXX Cost of Production XXXXX Add: Opening Finished Goods Stock XXXXX Less: Closing Finished Goods Stock XXXXX Cost of Goods Sold XXXXX Add: Selling and Distribution Overheads XXXXX Cost of Sales XXXXX Add: Profit XXXXX Sales XXXXX Note: In an absorption-costing cost sheet, fixed and variable factory overheads are both included in works cost. 11. Advantages of Absorption Costing Complete cost information: It includes all manufacturing costs. Useful for pricing: It helps determine selling prices by considering the full production cost. Stock valuation: It provides full manufacturing cost for inventory valuation. Financial reporting: It is suitable for external financial reporting, subject to applicable accounting standards. Profit determination: It helps calculate the overall profit of a business. Fixed cost recovery: It ensures fixed factory overhead is included in product cost. Long-term planning: It helps management consider the complete cost of manufacturing. Cost comparison: It helps compare production costs across different periods, provided the basis of costing remains consistent. 12. Disadvantages of Absorption Costing It is difficult to separate and allocate overheads accurately. It may create problems in comparing costs at different production levels. It includes fixed overhead in product cost, which may make short-term decisions difficult. The cost per unit can change with production volume because fixed overhead is spread over different numbers of units. It may encourage overproduction to increase reported profit when inventory increases. It does not clearly show the contribution earned by each product. It may not be suitable for certain short-term managerial decisions. Different methods of overhead allocation can produce different product costs. 13. Difference Between Absorption Costing and Marginal Costing This is one of the most important questions for BBA examinations. Basis Absorption Costing Marginal Costing Meaning Includes all manufacturing costs Includes only variable manufacturing costs Fixed Factory Overhead Product cost Period cost Variable Factory Overhead Product cost Product cost Direct Material Product cost Product cost Direct Labour Product cost Product cost Stock Valuation Full production cost Variable production cost Profit Affected by production and sales when stock changes Generally follows sales volume, assuming constant contribution and fixed cost Main Focus Total cost Contribution Use Financial reporting and inventory valuation Management decision-making Cost Per Unit Includes fixed and variable factory costs Includes variable manufacturing costs 14. Difference Between Product Cost and Period Cost Product Cost Product costs are the costs associated with manufacturing products. Examples: Direct material. Direct labour. Factory rent. Factory depreciation. Factory electricity. These costs are included in inventory until the goods are sold. Period Cost Period costs are costs charged to the accounting period in which they are incurred. Examples: Office rent. Advertising expenses. Selling expenses. Distribution expenses. Office salaries. These expenses are not included in inventory valuation. 15. Over-Absorption and Under-Absorption of Overheads A. Over-Absorption Over-absorption occurs when the overhead absorbed into production is greater than the actual overhead incurred. Example: Actual overhead = ₹50,000 Absorbed overhead = ₹55,000 Over-absorption: $$55,000-50,000=\text{₹}5,000$$ B. Under-Absorption Under-absorption occurs when the overhead absorbed into production is less than the actual overhead incurred. Example: Actual overhead = ₹60,000 Absorbed overhead = ₹50,000 Under-absorption: $$60,000-50,000=\text{₹}10,000$$ Difference Between Over-Absorption and Under-Absorption Basis Over-Absorption Under-Absorption Meaning Absorbed overhead exceeds actual overhead Absorbed overhead is less than actual overhead Effect Excess overhead charged Insufficient overhead charged Example ₹5,000 excess ₹10,000 shortage 16. Profit Difference Between Absorption and Marginal Costing The profit under absorption costing may differ from the profit under marginal costing because of the treatment of fixed factory overhead in closing stock. Important rule: When production is greater than sales, closing stock increases and absorption-costing profit is generally higher. When sales are greater than production, closing stock decreases and absorption-costing profit is generally lower. When production equals sales and there are no other inventory adjustments, profits are equal. Formula: $$\begin{array}{rl}{\displaystyle DifferenceinProfit=}& {\displaystyle ChangeinInventory}\\ {\displaystyle }& {\displaystyle \times FixedFactoryOverhead}\\ {\displaystyle }& {\displaystyle perUnit}\end{array}$$ This formula assumes a consistent fixed overhead rate and no other relevant adjustments. 17. Important Assumptions of Absorption Costing All manufacturing costs are included in product cost. Fixed factory overhead is absorbed into production. Variable manufacturing costs are included in product cost. Costs are allocated and apportioned using suitable bases. Production overhead absorption rates are calculated using an appropriate activity level. Selling and administrative expenses are treated as period expenses. Inventory is valued at full production cost, subject to applicable inventory valuation rules. 18. Importance of Absorption Costing in Business Absorption costing is important because: It determines the complete manufacturing cost of a product. It helps in valuing finished goods and work-in-progress inventory. It helps in preparing financial statements. It supports long-term pricing decisions. It helps calculate manufacturing profitability. It ensures fixed manufacturing overhead is considered in product costing. 19. Important Short Questions and Answers  Q1. What is absorption costing? Absorption costing is a method in which all fixed and variable manufacturing costs are included in the cost of a product. Q2. What is the main objective of absorption costing? Its main objective is to determine the total cost of production by including all manufacturing expenses. Q3. What is fixed factory overhead? It is a manufacturing expense that remains constant in total within a relevant range, such as factory rent and machinery depreciation. Q4. What is overhead absorption? It is the process of charging indirect manufacturing expenses to products or jobs. Q5. What is over-absorption? It occurs when the overhead charged to production is more than the actual overhead incurred. Q6. What is under-absorption? It occurs when the overhead charged to production is less than the actual overhead incurred. Q7. What is product cost? Product cost includes all manufacturing expenses incurred to produce goods. Q8. What is period cost? Period cost is an expense charged to the accounting period in which it is incurred. Q9. How is closing stock valued under absorption costing? Closing stock is valued at full production cost, including fixed and variable manufacturing costs. Q10. What is the main difference between marginal and absorption costing? Absorption costing includes fixed and variable manufacturing costs, whereas marginal costing includes only variable manufacturing costs in product cost. 20. Important Numerical Questions for Practice Try these questions to prepare for your BBA examinations. Test your understanding 4/5 completed Q1. A company produces 1,000 units. Direct material ₹20,000, direct labour ₹10,000, variable overhead ₹5,000 and fixed overhead ₹15,000. Calculate cost per unit. Q2. Actual factory overhead is ₹80,000 and absorbed overhead is ₹90,000. Calculate over-absorption. Answer: ₹10,000 over-absorption Q3. Actual overhead is ₹75,000 and absorbed overhead is ₹65,000. Calculate under-absorption. Answer: ₹10,000 under-absorption Q4. Fixed factory overhead is ₹40,000 and production is 2,000 units. Calculate fixed overhead per unit. Answer: ₹20 per unit Q5. Total production cost is ₹1,50,000 and production is 3,000 units. Calculate cost per unit. Answer: ₹50 per unit 21. Most Important Topics for BBA Examinations Topic Exam importance Meaning and definition Very important Features of absorption costing Very important Elements of absorption costing Very important Methods of overhead absorption Very important Cost sheet preparation Very important Advantages and disadvantages Important Marginal vs absorption costing Very important Over- and under-absorption Important Product cost and period cost Important Numerical problems Very important Conclusion Absorption costing is an important technique of cost accounting in which all manufacturing costs, including fixed and variable overheads, are included in the cost of products. It helps determine total production cost, cost per unit, inventory valuation and profit. It is particularly useful for financial reporting and long-term cost analysis. Exam Tip: Prepare the difference between marginal costing and absorption costing, overhead absorption methods, cost sheet preparation and numerical problems thoroughly. These are important areas for both theoretical and practical questions.	Importan