CAF-5 · Chapter 9
Marginal Costing and Absorption Costing MCQs with Answers
10 multiple-choice questions on Marginal Costing and Absorption Costing for CAF-5 Management Accounting. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
What is the fundamental difference between marginal costing and absorption costing?
- A) The treatment of variable production overheads
- B) The treatment of fixed production overheads
- C) The treatment of variable selling and administration costs
- D) The treatment of direct labour costs
Show answer & explanation
Answer: B) The treatment of fixed production overheads
The core difference between the two costing methods lies in how they handle fixed production overheads. Absorption costing includes them in the product cost (and thus inventory), while marginal costing treats them strictly as a period cost.
Question 2
Under a marginal costing system, how are fixed production overheads treated in the financial period they are incurred?
- A) They are capitalized into the closing inventory valuation.
- B) They are treated as a product cost and only expensed when the goods are sold.
- C) They are treated as a period cost and written off entirely in the Statement of Profit or Loss.
- D) They are apportioned based on direct labour hours and added to the prime cost.
Show answer & explanation
Answer: C) They are treated as a period cost and written off entirely in the Statement of Profit or Loss.
In marginal costing, fixed production overheads are not attached to units of production. Instead, the total actual fixed production overhead incurred is treated as a period cost and deducted in full from the total contribution margin.
Question 3
In an absorption costing income statement, how are variable selling and administration expenses accounted for?
- A) They are included in the cost of goods manufactured.
- B) They are included in the valuation of closing inventory.
- C) They are treated as a period cost and deducted from the gross profit.
- D) They are deducted directly from sales to arrive at the gross profit.
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Answer: C) They are treated as a period cost and deducted from the gross profit.
Under absorption costing, only manufacturing/production costs are included in the cost of sales to arrive at Gross Profit. All non-production costs, including variable selling and administration, are period costs deducted from Gross Profit.
Question 4
When a company's production volume exceeds its sales volume during a specific period, how will the net profit compare between the two costing methods?
- A) Marginal costing will report a higher net profit than absorption costing.
- B) Absorption costing will report a higher net profit than marginal costing.
- C) Both methods will report exactly the same net profit.
- D) The profit difference depends entirely on the variable cost per unit.
Show answer & explanation
Answer: B) Absorption costing will report a higher net profit than marginal costing.
When production exceeds sales, inventory levels increase. Under absorption costing, a portion of the current period's fixed production overheads is deferred (carried forward) in the closing inventory valuation, reducing the cost of sales and thereby resulting in a higher profit compared to marginal costing.
Question 5
Which of the following components are included in the valuation of closing inventory under absorption costing?
- A) Direct materials, direct labour, and variable production overheads only.
- B) Prime cost, variable production overheads, and fixed production overheads.
- C) Prime cost, variable production overheads, and variable selling overheads.
- D) Total production costs and total administrative costs.
Show answer & explanation
Answer: B) Prime cost, variable production overheads, and fixed production overheads.
Absorption costing charges all production costs to the product. This includes direct materials and direct labour (Prime Cost), variable production overheads, and a fair share of fixed production overheads.
Question 6
A company had an opening inventory of 4,000 units and a closing inventory of 6,000 units. The fixed overhead absorption rate (OAR) is Rs. 15 per unit. If the net profit calculated under marginal costing is Rs. 120,000, what will be the net profit under absorption costing?
- A) Rs. 150,000
- B) Rs. 90,000
- C) Rs. 120,000
- D) Rs. 180,000
Show answer & explanation
Answer: A) Rs. 150,000
The difference in profit is calculated by the change in inventory units multiplied by the fixed OAR. Change in inventory = Closing (6,000) - Opening (4,000) = +2,000 units. Profit Difference = 2,000 units × Rs. 15 = Rs. 30,000. Since inventory increased (Production > Sales), Absorption Profit is higher. Absorption Profit = Marginal Profit (120,000) + Difference (30,000) = Rs. 150,000.
Question 7
In a marginal costing income statement, what is deducted from Sales Revenue to arrive at the "Contribution Margin"?
- A) Variable production costs only
- B) Cost of goods sold
- C) All variable costs (including production, selling, and administration)
- D) Fixed production overheads
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Answer: C) All variable costs (including production, selling, and administration)
In a standard marginal costing format, Contribution Margin is derived by subtracting all variable costs (both manufacturing variable costs and non-manufacturing variable selling/admin costs) from the sales revenue.
Question 8
Which of the following situations will require an adjustment for "under or over-absorbed overheads" in the income statement?
- A) When using Marginal Costing, and actual production matches budgeted production.
- B) When using Absorption Costing, and actual activity levels or actual fixed costs differ from the budgeted estimates.
- C) When using Marginal Costing, and actual fixed costs exceed budgeted fixed costs.
- D) When sales volume is greater than the production volume.
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Answer: B) When using Absorption Costing, and actual activity levels or actual fixed costs differ from the budgeted estimates.
Absorption costing uses a pre-determined overhead absorption rate (OAR). If actual overheads differ from budgeted overheads, or actual production differs from budgeted production, it creates an under or over-absorption of fixed overheads which must be adjusted in the income statement. Marginal costing does not use fixed OARs, so this adjustment does not exist there.
Question 9
When reconciling marginal costing profit to absorption costing profit, which of the following formulas correctly calculates the difference in profit?
- A) (Opening Inventory Units - Closing Inventory Units) × Variable Cost per unit
- B) (Closing Inventory Units - Opening Inventory Units) × Fixed Overhead Absorption Rate per unit
- C) Total fixed production overheads divided by actual units produced
- D) Expected Sales minus Actual Sales
Show answer & explanation
Answer: B) (Closing Inventory Units - Opening Inventory Units) × Fixed Overhead Absorption Rate per unit
The absolute difference between marginal and absorption profit is solely driven by the amount of fixed overhead trapped in inventory. This is calculated by multiplying the difference in physical inventory units by the standard Fixed Overhead Absorption Rate (OAR) per unit.
Question 10
When comparing absorption costing with marginal costing, under which specific condition will the net profit reported by both methods be exactly the same?
- A) When production volume is greater than sales volume.
- B) When sales volume is greater than production volume.
- C) When there is no opening or closing inventory (Production volume equals Sales volume).
- D) When fixed production overheads are higher than variable production overheads.
Show answer & explanation
Answer: C) When there is no opening or closing inventory (Production volume equals Sales volume).
If a company sells exactly what it produces in a period, inventory levels do not change. Consequently, all fixed production overheads incurred in that period are charged to the income statement in both methods, resulting in identical net profits.