What Is Marginal Costing?
How variable-cost-only costing works, and why its profit can differ from absorption costing.
Home › Accounting Glossary › Marginal Costing
| Also called | Variable costing, direct costing |
|---|---|
| Compare with | Absorption costing |
| Best for | Internal decisions: pricing, special orders, CVP analysis |
Marginal costing in plain English
Marginal costing asks: what extra cost does one more unit cause? Only variable costs change with output, so only they go into unit cost. It works hand in hand with contribution margin and break-even analysis.
Worked example: why profits differ
A factory makes 10,000 units but sells only 9,000. Variable cost is 20 per unit and fixed overhead is 80,000 (8 per unit under absorption costing).
| Marginal costing | Absorption costing | |
|---|---|---|
| Fixed overhead charged this period | 80,000 (all of it) | 72,000 (9,000 × 8) |
| Fixed overhead held in closing inventory | 0 | 8,000 (1,000 × 8) |
Because 1,000 units are unsold, absorption costing defers 8,000 of fixed overhead into inventory. Its profit is therefore 8,000 higher than under marginal costing.
- Using marginal costing to value inventory for external financial statements. Standards require a share of production overheads.
- Expecting the two methods to give the same profit when production and sales differ.
Frequently asked questions
When do marginal and absorption costing profits differ?
When opening and closing inventory levels differ. If production exceeds sales, absorption costing shows the higher profit.
Why is marginal costing useful for decisions?
It focuses on the costs that change with activity, which are the relevant costs for most short-term decisions.
Is marginal costing allowed in financial reporting?
Not for valuing inventory in external statements under IFRS. It is used internally.
Keep learning
This page is for general learning. Accounting rules vary by country and standard.