Absorption vs marginal costing

In this lesson

1. 0:00 Absorption vs Marginal Costing Fundamentals
2. 1:02 Understanding Cost Cards and Prime Cost
3. 2:03 Valuing Inventory Under Each Approach
4. 3:52 Worked Example: Profit Calculation Setup
5. 5:28 Absorption Costing Profit Calculation
6. 9:02 Marginal Costing Profit Calculation
7. 10:40 Reconciling Profits and Inventory Impact
8. 13:58 Reconciliation Formula with Changing Inventory
9. 15:49 Calculating Overhead Absorption Rate

About this lesson

This distinction is crucial for Performance Management and Advanced Performance Management papers, where you need to reconcile profits between the two approaches and understand why inventory changes cause different reported results. In absorption costing, you include both variable and fixed production costs in your inventory valuation and cost of sales. In marginal costing, you only include variable costs, treating fixed overheads as a lump sum expense. The key insight is this: when inventory increases, absorption costing always reports higher profit because it defers some fixed costs to the next period. When inventory decreases, marginal costing reports higher profit. The difference between the two profits always equals the change in inventory multiplied by the fixed overhead absorption rate per unit. This video walks through a complete worked example showing how to construct profit and loss accounts under both methods, then demonstrates how to reconcile the different profit figures. You'll see exactly where the 5,000 difference arises when closing inventory is valued at 14,000 under absorption costing versus 9,000 under marginal costing. The final section teaches you a practical pro forma that works every time: you can always move between the two profit figures using the overhead absorption rate and inventory change, which is essential technique for exam questions that ask you to calculate profit under one method when given the other.

Duration: 18m