Question

Define variable costing and absorption costing. What are some of the benefits to a manager from using variable costing instead of absorption costing for internal decision making?

Answer 1

Variable Costing (Sometime called as direct costing):

In this costing the total variable cost is allocated over the produced unit. It is also known as marginal costing. In simple words we can say that in this type of costing all the variable costs are included in the product cost.

Variable cost is directly related to the volume of production.

The following formula can be used for calculating total variable cost.

Total variable costs = Quantity of products produced x Variable cost per unit

Absorption Costing:

In this type of costing technique along with variable costs fixed costs are also allocated to the products produced.

It allocates the fixed cost in the products even if it is not sold. Most of the costs are included in the ending inventory, which is carried over into the next period as an asset on the balance sheet.In this type of costing expense on income statement is low as most of the expenses are allocated in the closing inventory.

Q. What are some of the benefits to a manager from using variable costing instead of absorption costing for internal decision making?

a) If potential profitability of various products are compared. It is easy to find out the difference in the profit for each segment if variable costing is used.

b) If in a company there is a large amount of fixed overheads then it will be difficult to find out variation in the different level of production in case of absorption costing.

c) If absorption costing is used fixed costs are also allocated to the products produced during the period even if it not sold. This can lead the profit of the company seems better than it actually is. It can mislead investors.

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