Businesses have to be educated on the different types of costs involved in running a business; therefore managers are a vital part of the business and one of the most important aspects of their job is to determine the type of costing that will be used. As mentioned in the last two discussions, there are several types of costs and the two in this week’s reading are variable and absorption costing. Absorption costing is a system in which a certain portion of the fixed overhead costs is applied to the cost of manufacturing products. This is done on a per-unit basis; it works by basically dividing the total amount designated to fixed costs by the number of units manufactured and sold during a particular period. The result of that division is the cost per unit for each unit made and sold (Johnston, 2014). On the other hand, variable costing, also known as direct costing or marginal costing, utilizes a fixed overhead as one large sum, instead of a per-unit expenditure. In this type of costing, all the variable costs such as supplies, raw materials and shipping are included in that total sum, the entire cost pf the fixed period for that particular period. Unlike absorption costing, in variable costing the fixed overhead is subtracted from the total revenue of the business (Johnston, 2014).
Noreen (2011) states that variable costing is only determined by fluctuations in unit sales. This type of costing is not based on the number of units manufactured. Simply put when sales increase, the total net operating income increases as well and vice versa. One of the advantages of using variable costing is that the company can get a good picture of what the total business expenditures are. It does have the possibility though to make companies understate the complete cost of a product (Wilkinson, 2013).
Johnston, K. (2014). Advantages & Disadvantages of Using Absorption Vs. Variable Costing. Retrieved September 19, 2014, from http://smallbusiness.chron.com/advantages-disadvantages-using-absorption-vs-variable-costing-34282.html
Noreen, E., Brewer, P., & Garrison, R. (2011). Managerial Accounting for Managers (2 ed.). New York, NY: McGraw- Hill Companies.
Wilkinson, J. (2013, July 22). Absorption vs variable costing Advantages and Disadvantages • The Strategic CFO. Retrieved September 20, 2014, from http://strategiccfo.com/wikicfo/absorption-vs-variable-costing-advantages-and-disadvantages
Discussion #3: Absorption and Variable Costing
Variable and absorption costing are alternative methods of determining unit product costs (Noreen, Brewer & Garrison, 2014). From an article I read I needed more clarity on this subject. Absorption costing system, this refers to product costs that include direct labor, both fixed and variable overhead and direct materials. Therefore, absorption costing uses a portion of manufacturing overhead cost is allocated to each unit of product. This is regarded as full costing method, as all these costs of production are included in product cost.
Variable costing are referred to all the costs of production that vary without product costs. Variable costing include direct labor, direct materials and part of manufacturing overhead. This is called direct costing or marginal costing (Accounting explanation, 2014).
From another article I read about these two aforementioned topics it lists the advantages and disadvantages of both these terms. The advantages of Absorption costing takes in the account of per-unit amount for fixed expenses and each product in inventory. So each unit has an applied value that is part of the overhead. So therefore, you do not show the actual expense until you sell any of the items in the inventory. Thereby, maintaining your profit for that specific period.
The disadvantages of Absorption costing can make your profits look bigger than they really are in any accounting period. As will not subtract your entire fixed overhead if you did not sell all of the made products. Therefore your profit and loss statement does not represent all the full expenses you had for the period. This can throw you off when figuring out your profits for a certain period.
Advantages of Variable costing, this represents your profits made after all expenses have been paid for a particular accounting period. Therefore, when you
sell the manufactured products in inventory; you have a surplus of income.
Then the disadvantages of variable costing will represent the full payment for
fixed overhead. As this will then show less profit for a particular accounting
period as you show your complete overhead expense even when you did not sell
all your products. Therefore, in the end you will show reduced income for the
unsold products along with fixed expenses for overhead (Johnson, 2014).
Johnson, K. (2014). Advantages and Disadvantages of using absorption versus variable
Noreen, E.W., & Brewer, P.C. & Garrison, R, H. (2014). Managerial Accounting
for Managers. New York, NY: McGraw- Hill Companies.
Variable costing versus absorption costing. (2014). Retrieved September 18,