Absorption Costing free essay sample

Absorption costing: * It is costing system which treats all manufacturing costs including both the fixed and variable costs as product costs * In absorption costing, all costs are absorbed into production and thus operating statements do not distinguish between fixed and variable costs. * Absorption costing is a process of tracing the variable costs of production and the fixed costs of production to the product. Absorption costing is used to cost products and to report financial performance. The cost of a product is made up of those direct costs that can be related directly to making it. For example the direct cost of a chair might be: 10 metres of wood at ? 6. 00 per metre 1 piece of moulded plastic 20 screws and washers 30 minutes of time Marginal costing: * It is a costing system which treats only the variable manufacturing costs as product costs. The fixed manufacturing overheads are regarded as period cost * In marginal costing, fixed production costs are treated as period cost and are written off as they are incurred The difference between marginal costing amp; absorption costing is as below: 1. We will write a custom essay sample on Absorption Costing or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page Under marginal costing: for product costing amp; inventory valuation, only variable cost is considered whereas, Under absorption costing; for product costing amp; inventory valuation, both fixed cost amp; variable cost are considered. 2. Under marginal costing, there is a different treatment of fixed overhead. Fixed cost is considered as period cost amp; by Profit/Volume ratio (P/V ratio), profitability of different products is judged. On the other hand, under absorption costing system, the fixed cost is charged to cost of production. A reasonable share of fixed cost is to be borne by each product amp; thereby subjective apportionment of fixed overheads influences the profitability of product. 3. Under marginal costing, the presentation of data is so oriented that total contribution amp; contribution from each product gets highlighted. Under absorption costing, the presentation of cost data is on conventional pattern. After deducting fixed overhead, the net profit of each product is determined. 4. Under marginal costing, the unit cost of production does not get affected by the difference in the magnitude of opening stock amp; closing stock. Whereas, under absorption costing, due to the impact of the related fixed overheads, the unit cost of production get affected by the difference in the magnitude of opening stock amp; closing stock Financial Accounting Financial accounting is used to present the financial health of an organization to its external stakeholders. Board of directors, stockholders, financial institutions and other investors are the audience for financial accounting reports. Financial accounting presents a specific period of time in the past and enables the audience to see how the company has performed. Financial accounting reports must be filed on an annual basis, and for publically traded companies, the annual report must be made part of the public record. Management Accounting Management or managerial accounting is used by managers to make decisions concerning the day-to-day operations of a business. It is based not on past performance, but on current and future trends, which does not allow for exact numbers. Because managers often have to make operation decisions in a short period of time in a fluctuating environment, management accounting relies heavily on forecasting of markets and trends. Differences Management accounting is presented internally, whereas financial accounting is meant for external stakeholders. Although  financial management  is of great importance to current and potential investors, management accounting is necessary for managers to make current and future financial decisions. Financial accounting is precise and must adhere to Generally Accepted Accounting Principles (GAAP), but management accounting is often more of a guess or estimate, since most managers do not have time for exact numbers when a decision needs to be made. Management Accounting (MA) deals with non financial and a bit financial accounting. MA is very internal and it looks at the costs of production, how costs should be allocated, using labour hours, what costing method should we use, activity based costing or full cost costing. Financial accounting (FA) looks at financial information only. Like profit, sales, gross profit, and cost of sales. FA has accounting standards to follow like the  Accounting Standards (IAS). Whilst the MA can be presented in any form. FA is usually to communicate to the External Stakeholders (Govt, Owners, Customer, Banks etc.. ) and MA is usually for Internal Stakeholders (Employees, Managers, CEOs) Financial Accounts| Management Accounts| Financial accounts describe the performance of a business over a specific period and the state of affairs at the end of that period. The specific period is often referred to as the Trading Period and is usually one year long. The period-end date as the Balance Sheet Date| Management accounts are used to help management record, plan and control the activities of a business and to assist in the decision-making process. They can be prepared for any period (for example, many retailers prepare daily management information on sales, margins and stock levels). Companies that are incorporated under the Companies Act 1989 are required by law to prepare and publish financial accounts. The level of detail required in these accounts reflects the size of the business with smaller companies being required to prepare only brief accounts. | There is no legal requirement to prepare management accounts, although few (if any) well-run businesses can survive with out them. | The format of published financial accounts is determined by several different regulatory elements: ·Ã‚  Ã‚   Company Law ·Ã‚  Ã‚   Accounting Standards ·Ã‚  Ã‚   Stock Exchange| There is no pre-determined format for management accounts. They can be as detailed or brief as management wish. | Financial accounts concentrate on the business as a whole rather than analysing the component parts of the business. For example, sales are aggregated to provide a figure for total sales rather than publish a detailed analysis of sales by product, market etc. | Management accounts can focus on specific areas of a business activities. For example, they can provide insights into performance of: ·Ã‚  Ã‚   Products ·Ã‚  Ã‚   Separate business locations (e. g. hops) ·Ã‚  Ã‚   Departments / divisions| Most financial accounting information is of a monetary nature| Management accounts usually include a wide variety of non-financial information. For example, management accounts often include analysis of:- Employees (number, costs, productivity etc. )- Sales volumes (units sold etc. )-  Customer transactions (e. g. number of calls received into a call centre)| By definition, financial accounts present a historic perspective on the financial performance of the business| Management accounts largely focus on analysing historical performance. However, they also usually include some forward-looking elements e. g. a sales budget; cash-flow forecast. | Financial Accounting| Managerial Accounting| * Reports to those outside the organization owners, lenders, tax authorities and  regulators. | * Reports to those inside the organization for planning, directing and motivating, controlling and  performance evaluation. | * Emphasis is on summaries of financial consequences of past activities. | * Emphasis is on decisions affecting the future. | * Objectivity and verifiability of data are emphasized. * Relevance of items relating to decision making is emphasized. | * Precision of information is required. | * Timeliness of information is required. | * Only summarized data for the entire organization is prepared. | * Detailed segment reports about departments, products, customers, and employees are prepared. | * Must follow  Generally Accepted Accounting Principles (GAAP). | * Need not follow  Generally Accepted Accounting Pr inciples (GAAP). | * Mandatory for external reports. | * Not mandatory. |