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