Variable And Absorption: Two Different Costing Methods

Variable and Absorption are two different costing methods. Both used widely by a significant amount of successful companies in the world. Both methods cannot be substituted for one another because both the systems have their own advantages and disadvantages. These cost methods are known by various names. For example, variable costing is also known as direct costing or marginal costing and absorption costing is also known as full costing or traditional costing. Internal management mostly uses the information provided by variable costing method for decision-making purposes. Absorption costing provides information that is used by internal management as well as by external parties like creditors, government agencies and auditors etc.

Certain organizations

Under this method, all variable cost are added and included such as supplies, raw materials and shipping. The full cost of fixed overhead for the period are also included. Unlike with absorption costing these are not figured on a per-unit basis. Instead you subtract them from your revenues as a lump-sum expense.

This method may provide a clearer picture of the actual incremental costs associated with a specific product. Essentially, the variable costing method can give producers and those concerned with financial records an accurate representation of what actually goes into the costs of producing. Proponents of variable costing argue that fixed manufacturing overhead costs are incurred regardless of production volume and therefore should not be considered in product-related decision-making. Therefore, variable costing method produces a reported cost that is representative of the actual inputs to the

Though revenues may not have been received for the products manufactured because some could be in inventory, all expenses for the period are reported as paid. When all finished products in inventory is finally sold, a surplus income will be reported. However, by ignoring fixed manufacturing overhead costs, variable costing may understate a product’s overall cost. Manufacturing overhead is important because, though the costs included in overhead do not contribute directly to the creation of the product, there is still some residual effect on the production that drives up the cost to produce.

Variable costing also carries the disadvantage of showing full payment for fixed-overhead expenses for the accounting period. Even if all the goods manufactured have not been sold, the full cost of fixed overhead must still be deducted. This means less profit is shown for the period because your complete overhead expense is reported even when all of your products haven’t been sold. Reduced income because of unsold products and full expenses for overhead are