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Could you please explain to me why would a decrease in inventory would cause for me to deduct the it from my total marginal costing profit? Over all could you please recap on the topic specifically on marginal since I know that when there is an increase inventory in absorption there will be higher profits.
Thats because of difference in profits due to different methods of inventory valuations.
In Absorption Costing, inventory is valued at Marginal Cost + Absorbed Overheads/unit, which is definitely higher than Marginal Costing where inventory is valued at Marginal Cost only.
Now, in Abs. Costing, the closing inventory units carry some fixed overheads with them, which will be written off against profit in next period when they’ll eventually be sold.
While in Marginal Costing, those closing inventory units will not be carrying fixed overheads with them, instead the total fixed overheads will be written off against profit.Coming onto your query…
Absorption Costing:
If there’s a decrease in inventory, meaning that the opening inventory is greater than closing inventory, then greater amount of fixed overheads will be charged against profit for the period (FOH present in Opening Inv. and Produced Inv.). FOH for present period alongwith some amount from previous period is also deducted from profit.Marginal Costing:
Opening Inventory or Closing Inventory doesn’t contain any FOH. Only the FOH for the period will be deducted from profit, thats why Marginal Costing profit will be greater than that of Absorption Costing.For reconciliation, we’ll subtract the ‘additional FOH’ amount from Marginal Costing Profit and both the profits will reconcile.
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