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Variable Costing vs Absorption Costing
In order to match costs and revenue, cost of stocks and work in progress should comprise that expenditure which has been incurred in the normal course of business in bringing the product or service to its present location and condition. Such costs will include all related production overheads, even though these may accrue on a time basis.
The effect of this statement in SSAP 9 was to require the use of absorption costing method for external reporting. This would also call for consistency in the methods used for calculating costs to ensure companies report a true and fair view of figures presented.
Marginal costing emphasises on contribution. But the problem with calculating contribution of products produced by a company is that it does not necessarily mean profit earned as it has yet to cover fixed costs. Whereas in absorption costing, by charging all fixed manufacturing costs to a product would possibly determine whether it is profitable or not. In an absorption costing system, fixed overheads will be deferred and included in the closing stock valuation, and will be recorded as expense only in the period in which the goods are sold. Losses are therefore unlikely to be reported in the periods when stocks are being built up. In these circumstances, absorption costing appears to provide a more logical profit calculation hence avoids fictitious losses being reported.
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