Absorption Costing/Marginal Costing – Inventory valuation, effect on profit

If production is greater than sales, then the inventory will increase.

With absorption costing, the inventory valuation includes fixed overheads, which means that if inventory increases then some of the fixed overhead is carried forward in the valuation of inventory. So the amount left as charged for the year is lower and so the profit is higher.

Or….if it is more obvious – with absorption costing the inventory is valued higher because it includes fixed overheads. If closing inventory is higher, then when you subtract inventory from the cost of production to get cost of sales, the amount subtracted is higher and so the cost of sales is lower. If cost of sales is lower then the profit will be higher.