Profit statements under marginal and absorption costing

Marginal costing statement

Revenue

less variable cost of sales (opening inventory + variable production costs - closing inventory, all at variable cost)

= Contribution

less fixed costs (all of them: production, administration, selling)

= Profit

Absorption costing statement

Revenue

less cost of sales (opening inventory + full production cost - closing inventory, at full cost)

= Gross profit

less non-production overheads (administration, selling)

= Profit

If actual fixed production overhead differs from the amount absorbed, adjust cost of sales for under- or over-absorption.

Worked statements

10,000 units made, 8,000 sold at £30; variable cost £12; fixed production overhead £60,000 (absorbed at £6); administration £20,000. No opening inventory.

Reconciling the profits

Difference = change in inventory (units) x fixed overhead absorption rate.

Here inventory rose by 2,000 units: 2,000 x £6 = £12,000 = 76,000 - 64,000.

• Inventory rising (production > sales): absorption profit is higher (fixed cost carried forward).
• Inventory falling: absorption profit is lower (last year's fixed cost released).
• No change: profits are equal.

Over the whole life of a business the total profit is the same; only the timing differs.

Worked example

Next year the firm makes 10,000 units and sells 11,500 (opening inventory 2,000 units, closing 500). All costs and prices are unchanged. Which method shows the higher profit, and by how much?

1. Inventory falls by 1,500 units
2. Difference = 1,500 x £6 = £9,000
3. Absorption costing releases fixed overhead from opening inventory, so its profit is lower

Answer: Marginal costing profit is higher by £9,000

Check yourself

1. Sales 4,000 units at £50; production 5,000 units; variable cost £20 per unit; fixed production overhead £45,000; administration £15,000; no opening inventory. Calculate the marginal costing profit.
   Show answer

   £60000. Contribution = 4,000 x 30 = 120,000; profit = 120,000 - 45,000 - 15,000 = £60,000.

2. Same data (sales 4,000 at £50, production 5,000, variable cost £20, fixed production overhead £45,000 absorbed over 5,000 units, administration £15,000). Calculate the absorption costing profit.
   Show answer

   £69000. Full cost £29; gross profit = 4,000 x 21 = 84,000; profit = 84,000 - 15,000 = £69,000.

3. Absorption costing profit is £82,000. Inventory fell by 600 units during the year and the OAR is £7 per unit. Calculate the marginal costing profit.
   Show answer

   £86200. Inventory fell, so marginal profit is higher: 82,000 + 4,200 = £86,200.

4. Revenue £360,000; variable cost of sales £198,000; fixed costs £110,000. Calculate the contribution.
   Show answer

   £162000. 360,000 - 198,000 = £162,000.

5. Production exceeds sales during a year. Which statement is true?
   • Marginal costing profit is higher
   • Absorption costing profit is higher than marginal costing profit
   • The profits are equal
   • Marginal costing shows a loss
   Show answer

   Absorption costing profit is higher than marginal costing profit. Part of this year's fixed overhead is carried forward in closing inventory under absorption costing.

6. When will marginal and absorption costing profits be the same?
   • When there are no fixed costs in administration
   • When sales exceed production
   • Never
   • When opening and closing inventory levels are the same
   Show answer

   When opening and closing inventory levels are the same. With no change in inventory, no fixed overhead is carried forward or released.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Accounting specification (XAC11/YAC11), Issue 2
• Pearson Edexcel IAL Accounting WAC12 Unit 2 mark scheme, June 2022

Last updated 8 November 2026. Spotted a mistake? Tell us.