Study tips: What’s the difference between marginal and absorption costing?

Understanding marginal and absorption costing should be relatively straightforward, as it’s covered, in one form or another, at all levels of the AAT qualification. However, it’s a topic that continues to challenge us.

Let’s start by clarifying that both methods are concerned with production costs and both require good foundation knowledge of cost categorisation.

  • Marginal costing is based on classifying costs by behaviour, in other words, whether a cost is variable or fixed.
  • Absorption costing focuses on whether a cost is direct or indirect by nature.  

Generally, if a cost is variable, such as a production worker’s wages, then it’s also direct. Equally, fixed costs are usually indirect, for example factory rent.

This explains why calculations can be ‘built up’ starting with the prime cost, which is the total of all the direct costs, then adding any variable overheads in order to calculate the marginal cost.

When we add the indirect costs to the marginal cost we end up with the full cost.