How do marginal and absorption costing treat costs differently, and when does it matter?
The distinction between fixed and variable costs, the meaning of contribution, marginal costing and its use in short-term decisions, absorption costing and overhead absorption, and the difference in reported profit between the two methods.
A focused answer to AQA A-Level Accounting 3.2, covering fixed and variable costs, contribution, marginal costing for short-term decisions, absorption costing and overhead absorption, and why reported profit differs between the two methods.
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What this dot point is asking
AQA wants you to distinguish fixed from variable costs, calculate contribution, apply marginal costing to short-term decisions, use absorption costing with overhead absorption, and explain why profit differs between the two methods. This is unit 3.2.2, and a profit comparison with reconciliation, plus a special-order or make-or-buy decision, are standard Paper 2 tasks.
Cost behaviour and contribution
Marginal costing
The reason marginal costing suits short-term decisions is that, in the short term, fixed costs are unavoidable and unchanged by the decision, so they are irrelevant to it. The relevant comparison is the extra revenue against the extra (variable) cost. A special order priced above variable cost makes a positive contribution and, with spare capacity, raises total profit even if the price is below full cost. The same contribution-based logic decides make-or-buy (compare the variable cost of making with the buy-in price) and which product to favour when a resource such as labour hours is scarce (rank by contribution per unit of the scarce resource).
Absorption costing and the profit difference
When each is used
Marginal costing aids short-term decision-making because it isolates the avoidable (variable) cost. Absorption costing is required for the financial statements, because the accruals concept and inventory standards require closing inventory to include a fair share of production overheads, and it supports full-cost (cost-plus) pricing. The choice is therefore about purpose: decisions use marginal costing, external reporting uses absorption costing.
Try this
Q1. A product sells for with variable cost . Calculate the contribution per unit. [2 marks] .
Q2. State when marginal and absorption costing report the same profit. [1 mark] When there is no change in inventory (production equals sales).
Exam-style practice questions
Practice questions written in the style of AQA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
AQA 20198 marksA firm produces 10,000 units, sells 9,000 at 22 per unit and fixed overheads of $60,000. Calculate the profit under both marginal and absorption costing and reconcile the difference.Show worked answer →
A full worked comparison; the reconciliation is the key marking point.
Marginal costing: contribution = (40 - 22) times 9,000 sold = 18 times 9,000 = 60,000; profit = $102,000 (3 marks).
Absorption costing: fixed overhead per unit = 60,000 / 10,000 produced = 6 = 102,000 + 108,000 (3 marks).
Reconciliation: the $6,000 difference equals the fixed overhead in the increase in inventory; because production (10,000) exceeded sales (9,000), absorption profit is higher (2 marks). Markers reward both profit figures and the reconciliation tied to the inventory change.
AQA 20215 marksA business has spare capacity and receives a one-off order at a price below total cost but above variable cost. Evaluate whether it should accept the order.Show worked answer →
A 5-mark "Evaluate" answer applies marginal costing to a decision.
For: if the price exceeds the variable cost, the order makes a positive contribution towards fixed costs and profit; with spare capacity the fixed costs are unchanged, so any positive contribution improves total profit (2 marks).
Against: it may set a precedent or anger full-price customers; it uses capacity that could serve a better order; and if it is not truly one-off the fixed costs may eventually need covering (2 marks).
Judgement: accept if genuinely one-off, capacity is spare, and there is no damage to the main market, because the contribution adds to profit (1 mark). Markers reward using contribution not total cost as the decision rule, plus the qualitative risks.
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Sources & how we know this
- AQA A-level Accounting (7127) specification — AQA (2017)