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Variable Costing vs Absorption Costing – For students and CPA Candidates.

My video lectures  about variable costing vs absorption costing  can be found in my managerial accounting course, cost accounting or CPA exam BEC  section.  Browse from menu above.

Managerial Accounting Course

Managerial Accounting Course

 

Use variable costing to make management decisions for a manufacturing business.

  1. 1.Distinguish between variable costing and absorption costing

The purpose of managerial accounting is to provide managers with information that is useful for internal decision making—for planning, directing, and controlling decisions. As you have seen, this type of information often differs from the financial accounting information provided to external users, such as investors and creditors. In this chapter, you study two methods of determining the cost of producing products and when each method is appropriate.

Variable Costing

Variable costing is an alternative costing method that considers only variable manufacturing costs when determining product costs. Variable costing includes direct materials costs, direct labor costs, and variable manufacturing overhead costs as product costs. Fixed manufacturing overhead costs are considered period costs and are expensed in the period in which they are incurred, because these costs are incurred whether or not the company manufactures any goods. Variable costing cannot be used for external reporting, but it is useful to managers for planning, directing, and controlling. The internal financial statements use the contribution margin income statement format with a focus on contribution margin. Contribution margin is the difference between net sales revenue and variable costs. It is the amount that contributes to covering the fixed costs and then to providing operating income

 Absorption Costing

Up to this point, we have illustrated the use of absorption costing when determining the cost of products. Absorption costing considers direct materials costs, direct labor costs, variable manufacturing overhead costs, and fixed manufacturing overhead costs as product costs. This approach is called absorption costing because the products absorb all of the manufacturing costs—materials, labor, and overhead. These costs are recorded first as assets in the inventory accounts. Later, when the product is sold, the costs are transferred to the expense account Cost of Goods Sold. Absorption costing is required by the Generally Accepted Accounting Principles (GAAP) for financial statements issued to investors, creditors, and other external users. The external financial statements use the traditional income statement format with a focus on gross profit.