Under absorption costing, how is inventory valuation different from marginal costing?

Under absorption costing, how is inventory valuation different from marginal costing?

• A. Absorption costing excludes fixed overhead in inventory
• B. Absorption costing includes fixed overhead in inventory; marginal costing excludes them
• C. Both include fixed overhead in inventory
• D. Neither includes fixed overhead in inventory

Answer: (D)

The key idea is how fixed manufacturing overhead is treated in inventory. In absorption costing, all manufacturing costs are attached to the product, so fixed overhead is included in the cost of inventory. When the inventory is sold, that fixed overhead appears in the cost of goods sold. In marginal (variable) costing, only variable manufacturing costs are included in the product cost; fixed overhead is treated as a period cost and expensed in the period it’s incurred, not added to inventory. So, under absorption costing the value of ending inventory includes a share of fixed overhead, whereas under marginal costing it does not. This is why inventory valuations differ between the two methods, and why profits can differ when inventory levels change across periods. For example, if you produce more than you sell, absorption costing defers some fixed overhead in inventory, pushing higher costs into inventory rather than immediately expensing them.

The key idea is how fixed manufacturing overhead is treated in inventory. In absorption costing, all manufacturing costs are attached to the product, so fixed overhead is included in the cost of inventory. When the inventory is sold, that fixed overhead appears in the cost of goods sold. In marginal (variable) costing, only variable manufacturing costs are included in the product cost; fixed overhead is treated as a period cost and expensed in the period it’s incurred, not added to inventory.

So, under absorption costing the value of ending inventory includes a share of fixed overhead, whereas under marginal costing it does not. This is why inventory valuations differ between the two methods, and why profits can differ when inventory levels change across periods. For example, if you produce more than you sell, absorption costing defers some fixed overhead in inventory, pushing higher costs into inventory rather than immediately expensing them.