Accounting Differences in Variable and Absorption Costing
Variable and Absorption Costing
What are the differences between variable and absorption costing methods? One of the biggest differences between variable costing and absorption costing is the way the fixed manufacturing cost is charged off. Both variable and absorption costing use direct cost, variable cost and variable manufacturing cost are seen as the product expense.
Variable costing charges off fixed manufacturing cost as period cost, in full at the end of each period. In doing this, the product cost will not reflect any fixed cost. Managers can use this information to get the bare minimum cost of production of a product. Many say that by not showing fixed manufacturing cost, it will be harder to keep accurate and competitive prices. They are essentially opening themselves up to failure if they charge to much, they will lose market shares. Yet if they under budget fixed manufacturing, the price could be far too less and they may lose money in the long run.
Absorption costing charges off fixed manufacturing cost as a product cost, so the product will reflect this overhead expense. This would be a full look at all cost contributing to the making of a product and can help managers decide on proper pricing. The only con to this type of costing is the amount of time needed to follow through with matching fixed manufacturing to each product. This method is far easier to use with manufacturers that make only a small limited amount of products, thus easier to cost match and more cost effective to use.
Either way, which ever form of costing use, it is only perfect after the fact. In both ways, managers will have to take the information into account for the coming period and make a budget. The application of each type of costing are GAAP approved, so whichever is chosen will have to be stuck to each period. If the costing method is changed because one is more suitable for your company, it must be noted in the Summary of Accounts and mentioned to the IRS when filing your next year's taxes.
Segmented Income Statement
With these types of costing, segmented income statements are used to differeciate between product types or business branches. The purpose of a segmented income statement is to get a more detailed look at one section, or segment of the company. If a manager wants to know anything in further detail about a certain division, product, or even a customer, a segment income statement will give a more in depth look at everything associated with the account. Potential problems with this type of income statement are the common cost that will not always be included, only traceable cost, which will not show true cost of products.