DIRECT AND ABSORPTION COSTING
MAC2601
1
, Introduction
An important aspect of product costing is to calculate the manufacturing cost per unit. This is done by
dividing the total manufacturing cost for a particular period by the number of units produced during this
period. For example, if the total manufacturing costs for 30 000 units is R90 000, then the cost per unit is
R3. The availability of a unit manufacturing cost makes it easy to determine the manufacturing costs of
units sold and units on hand. This information has an impact on the calculation of the net profit.
There are different opinions as to what should be included in the unit cost of manufacturing. Some people
favour absorption costing. Others favour marginal costing.
In absorption costing both the fixed cost and variable cost are included in the total manufacturing cost of a
product. In marginal costing only the variable cost is included in the manufacturing cost of a product.
Difference Between Direct Costing and Absorption Costing
In marginal costing (also called direct costing or variable costing), the manufacturing cost takes only the
variable manufacturing cost into account viz. direct material, direct labour, and variable manufacturing
overheads. When marginal income is calculated all variable costs (including selling and administrative
costs) are taken into account. Fixed manufacturing overheads are considered to be a period cost and are
written off in the period in which they were incurred.
In absorption costing (also called total costing or full cost method) the manufacturing cost takes both the
variable and fixed manufacturing costs into account. Fixed manufacturing overheads are classified as a
product cost and not as a period cost (as is the case with marginal costing).
2
, Preparing Income Statements According to Both the Marginal and Absorption Costing Methods
DIRECT COSTING METHOD ABSORPTION COSTING METHOD
Sales Sales
Less: Variable cost Less: Manufacturing cost
Direct material Direct material
Direct labour Direct labour
Variable manufacturing overheads Variable manufacturing overheads
Other variable costs: Fixed manufacturing overheads
Administrative expenses
Selling expenses
= Marginal income = Gross profit
Less: Fixed cost Less: Other costs
Manufacturing cost
Selling cost Selling cost (fixed & variable)
Administrative cost Administrative cost (fixed & variable)
= Net profit = Net profit
GENERAL KNOWLEDGE
DIRECT COSTING
If I want to know how much it cost to bake a bread, I will consider all the costs for flour, ingredients (direct
material) bakers (labour cost), transport cost for bringing material into the premises
ABSOPRTION
When applying this technique, I will consider both direct costs and fixed manufacturing costs such as the
money paid for rent expense
3
MAC2601
1
, Introduction
An important aspect of product costing is to calculate the manufacturing cost per unit. This is done by
dividing the total manufacturing cost for a particular period by the number of units produced during this
period. For example, if the total manufacturing costs for 30 000 units is R90 000, then the cost per unit is
R3. The availability of a unit manufacturing cost makes it easy to determine the manufacturing costs of
units sold and units on hand. This information has an impact on the calculation of the net profit.
There are different opinions as to what should be included in the unit cost of manufacturing. Some people
favour absorption costing. Others favour marginal costing.
In absorption costing both the fixed cost and variable cost are included in the total manufacturing cost of a
product. In marginal costing only the variable cost is included in the manufacturing cost of a product.
Difference Between Direct Costing and Absorption Costing
In marginal costing (also called direct costing or variable costing), the manufacturing cost takes only the
variable manufacturing cost into account viz. direct material, direct labour, and variable manufacturing
overheads. When marginal income is calculated all variable costs (including selling and administrative
costs) are taken into account. Fixed manufacturing overheads are considered to be a period cost and are
written off in the period in which they were incurred.
In absorption costing (also called total costing or full cost method) the manufacturing cost takes both the
variable and fixed manufacturing costs into account. Fixed manufacturing overheads are classified as a
product cost and not as a period cost (as is the case with marginal costing).
2
, Preparing Income Statements According to Both the Marginal and Absorption Costing Methods
DIRECT COSTING METHOD ABSORPTION COSTING METHOD
Sales Sales
Less: Variable cost Less: Manufacturing cost
Direct material Direct material
Direct labour Direct labour
Variable manufacturing overheads Variable manufacturing overheads
Other variable costs: Fixed manufacturing overheads
Administrative expenses
Selling expenses
= Marginal income = Gross profit
Less: Fixed cost Less: Other costs
Manufacturing cost
Selling cost Selling cost (fixed & variable)
Administrative cost Administrative cost (fixed & variable)
= Net profit = Net profit
GENERAL KNOWLEDGE
DIRECT COSTING
If I want to know how much it cost to bake a bread, I will consider all the costs for flour, ingredients (direct
material) bakers (labour cost), transport cost for bringing material into the premises
ABSOPRTION
When applying this technique, I will consider both direct costs and fixed manufacturing costs such as the
money paid for rent expense
3
