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When comparing the profits reported under marginal and absorption costing when the levels of inventories decreased (assuming unit variable and fixed costs are constant)
A absorption costing profits will be lower and closing inventory valuations higher than those under marginal costing
B absorption costing profits will be lower and closing inventory valuations lower than those under marginal costing
C absorption costing profits will be higher and closing inventory valuations lower than those under marginal costing
D absorption costing profits will be higher and closing inventory valuations higher than those
under marginal costingCorrect answer(s):
A absorption costing profits will be lower and closing inventory valuations higher than those under marginal costing
Closing inventory valuations are always higher with absorption costing because of the inclusions of fixed overhead. Therefore, the statements that closing inventory valuations are lower are incorrect. If inventories decrease, absorption costing profits are lower because of the fixed overhead being released from inventoryI think B correct. Decrease Inventory –> closing < opening –> absorption costing<marginal
A is correct.
I do illustrate (and explain why) in my free lectures on absorption and marginal costing, that if inventories increase then absorption costing gives the higher profit, whereas if inventories decrease then marginal costing gives the higher profit.
(With absorption costing, both the opening and closing inventories will be higher than in marginal costing.)
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