See Also:
Variable vs Fixed Cost
Semi Variable Costs
Activity Based Costing vs Traditional Costing
Standard Costing
Process CostingVariable vs Absorption Costing In the field of accounting, variable (direct) costing and absorption (full) costing are two different methods of applying production costs to products or services. The difference between the two methods is in the treatment of fixed manufacturing
overhead costs. Under the direct costing method, fixed manufacturing overhead costs are expensed during the period in which they are incurred. Under the full costing method, fixed manufacturing overhead costs are expensed when the product is sold.
Direct Costing MethodThe direct costing method applies all direct costs as well as variable manufacturing overhead costs to the end product. These costs move with the product through the inventory accounts until the product is sold, at which point they are expensed on the
income statement as costs of goods sold. Fixed manufacturing overhead costs are expensed during the period in which they are incurred.
Direct costing is also called
variable costing or marginal costing.
Full Costing MethodThe full costing method applies all direct costs and both fixed and variable manufacturing overhead costs to the end product. All of these costs move with the product through the inventory accounts until the product is sold, at which point they are expensed on the income statement as costs of goods sold.
Full costing is also called absorption costing.
Advantages and DisadvantagesVariable costing may provide a clearer picture of the actual incremental costs associated with a specific product. Proponents of variable costing argue that fixed manufacturing overhead costs are incurred regardless of production volume and therefore should not be considered in product-related decision-making. However, by ignoring fixed manufacturing overhead costs, variable costing may understate a product’s overall cost.
Absorption costing may provide a fuller picture of a product’s cost by including fixed manufacturing overhead costs. However, absorption costing ignores the differential usage of indirect resources across products or product lines. Also, absorption costing can be used as an accounting trick to increase
net income by moving fixed manufacturing overhead costs from the income statement to the
balance sheet simply by increasing production volume disproportionately to sales volume.
Absorption Costing GAAPAbsorption costing is required for external reporting by
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