Variable costing versus absorption costing
Explain the difference between variable and absorption costing. How unit product cost is computed under two methods?
Variable and absorption are two different costing methods. Almost all successful companies in the world use both the methods. Variable costing and absorption costing cannot be substituted for one another because both the systems have their own benefits and limitations.
These costing approaches are known by various names. For example, variable costing is also known as direct costing or marginal costing and absorption costing is also known as full costing or traditional costing.
The information provided by variable costing method is mostly used by internal management for decision making purposes. Absorption costing provides information that is used by internal management as well as by external parties like creditors, government agencies and auditors etc.
Computation of unit product cost under two methods:
Under absorption costing system, the product cost consists of all variable as well as all fixed manufacturing costs i.e., direct materials, direct labor and factory overhead (FOH). But when variable costing system is used, the fixed cost (both manufacturing and non-manufacturing) is treated as a period or capacity cost and is, therefore, not included in the product cost.
Following exhibition summarizes the difference between variable costing and absorption costing:
Variable versus absorption costing
For further clarification of the concept, consider the following examples:
Example 1
A company manufactures and sells 5000 units of product X per year . Suppose one unit of product X requires the following costs:
Direct materials: $5 per unit
Direct labor: $4 per unit
Variable manufacturing overhead: $1 per unit
Fixed manufacturing overhead: $20,000 per year
The unit product cost of the company is computed as follows:
Absorption Costing: $5 + $4 + $1 + $4* = $14
Variable Costing: $5 + $4 + $1 = $10
* $20,000 / 5,000
Notice that the fixed manufacturing overhead cost has not been included in the unit cost under variable costing system but it has been included in the unit cost under absorption costing system. This is the primary difference between variable and absorption costing.
Example 2
Sunshine company produces and sells only washing machines. The company uses variable costing for internal reporting and absorption costing for external reporting. The data for the year 2016 is given below:
Direct materials: $150/unit
Direct labor: $45/unit
Variable manufacturing overhead: $25/unit
Fixed manufacturing overhead: $160,000 per year
Fixed marketing and administrative expenses: $110,000 per year
Variable marketing and administrative expenses: $15/unit sold
Company produced and sold 8,000 machines during the year 2016.
Required: Compute the unite product cost under variable costing and absorption costing.
Solution:
*$160,000 / 8,000 Units = $20
Note: Marketing and administrative expenses are period costs and are not relevant in the computation of unit product cost.
54 Comments on Variable costing versus absorption costing
Yes it is useful.
I could have used a little more explanation of the variable costing method, however this was useful.
I can’t access Resource 1
Why is marketing and administrative expenses not relevant in the second example?
they are period cost in both method, not included in the computation of product cost.
Because they are not incurred to manufacture a product. In example 2, we are computing unit product cost, not net operating income. Read this article:
https://www.accountingformanagement.org/product-cost-and-period-cost/
Yes, I finally got costing!!!!!!!!!!!!!!
Thanks ..it is very useful
yes! I’ve learned a lot. Thank you 🙂
very useful thanks
How about when the unit production and unit sold are different? which one we have to choose to calculate the unit product cost?
Always units produced. You incur production cost to produce not sell.
See:
https://www.accountingformanagement.org/variable-and-absorption-costing-exercises/
https://www.accountingformanagement.org/variable-and-absorption-costing-problems/
thanks a lot.it’s very help full.
how is begining inventory treated
Thanx, have been helped.
It was helpful, thank you
very useful
Very useful. For me difference between understanding and not understanding.
can you help me to solve this problem
) Durante Company reported the following information about the production and sale of its only product during the first month of operations:
Selling price per unit $300
Sales $480,000
Direct materials used $220,000
Direct labor $200,000
Variable factory overhead $60,000
Fixed factory overhead $80,000
Variable selling and administrative expenses $20,000
Fixed selling and administrative expenses $10,000
Ending inventory, Direct Materials 0
Ending inventory, Work-in-process 0
Ending inventory, Finished Goods 400 units
Under variable costing, the cost of finished goods ending inventory is ________.
Total units manufactured during the month:
Units sold + units in ending inventory
1,600* + 400
= 2,000
*480,000/300
Variable manufacturing cost:
Direct materials used + Direct labor + Variable factory overhead
220,000 + 200,000 + 60,000
= 480,000
Variable manufacturing cost per unit:
$480,000/2,000 = $240
Cost of finished goods ending inventory:
400units*$240 = $96,000
How if the budgeted production is 40 000 and the actual production is 50 000. Which one will be use to determine the fix production overhead per unit? is it 300 000/50 000 or 300 000/40 000?
at the time i will be use 50000 units for FPOH.
Thanks is understandable
is absorption costing or variable costing system likely to be seen as more appropriate for use by the management
I think variable selling and admin fall in product cost in marginal costing. Correct me if i am wrong.
Can you please explains:
why absorption includes fixed costs?
Explains effect of ending inventory on operating income?
Clear on results of Production more than sales, sales more than production and sales equals production
Who is the author for this page for citation purposes?
Thanks
Is powdercoating treated as overhead cost?
How non production variable and fixed overheads are treated in marginal and absorption costing
Why we not included Admin and selling expenses in absoption mathod???
Sajjad Badar becaus admin& selling expenses is period costs not product costs, don,t forget we interest about product cost only that,s mean we compute manofactory expenses to detemine units cost not admin& selling expenses
Now I got a clearer picture of Variable and Absorption Costing Concepts right for the first time.
Thanks alot.
Patrick O.
What is used to compute unit price? Selling units or production units
Thank you it really helped me
Thanks…
Hey,
Is it true that absorption costing directs period costs to the product ?
which method is better for the Sunshine company?
I would like to be assisted with the following question:
1. The following budgeted information relates to a manufacturing company for next period:
production 14 000 sales 12000 units and fixed production costs R63000 and fixed selling costs R12000.
the normal level of activity is 14000 units per period.
using an absorption costing, the profit for the next period has been calculated as R36000.
what would be the profit for the next period using marginal costing.
As the inventory is increasing, the profit under absorption costing would be higher than the marginal costing.
Begining inventory: 0 units
Ending inventory: 14,000 – 12,000 = 2,000 units
Per unit fixed manufacturing cost: 63,000/14,000 = R4.5
Total cost of ending inventory: 2,000*4.5 = R9,000
Profit for the next period under marginal costing: R36,000 – R9,000 = R27,000
very much usefull
Hello,
Is that inventory and COGS under absorption costing are always higher than variable costing? If not, which one is correct statement? And how about fixed overhead expenses? Under which method has always higher fixed overhead expenses?
Thanks
As much as this is useful,
Can we conclude that in the long run, total costs incurred will be the same under a FIFO method?
I know that using one or the other can maximize net income but my question has to do with the long term nature of the cost.
If anyone can answer this it would be unreal!!
Thanks
please help me solve this
Bindu Ltd is a manufacturing company and has provided you with the following information for the two years ende 30 June 2002 and 30 June 2003
2002 units 2003 units
sales 4200 4400
production 4500 4800
fixed cost
manufacturing 36000 43200
unit data selling price 47 51
direct material 10 12
direct labour 15 18
variable prodution overhead 7 9
admin and marketing 11400 13680
there was no opening stock of finished goods in the ear ended 30 June
Stocks are valued on a FIFO basis
Required to calculate the closing stocks for each year using the absoption costing method and marginal costing method and the profit statements
PLEASE HELP ME!! WHICH BOOK CAN I FIND THIS PROBLEMS????? VERY USEFUL FOR FINAL EXAM
which problem bro?
Variable marketing and administrative expenses: $15/unit sold in example 2 what happen to it?
Pls help…
A Business manufacture plastic bags at the begining of the year there were 1000units.During the year 10,000units bags were produced & following cost was incured….
labour:-
skilled -2 (25) /unit
unskilled – 2 (30) /unit
Materials:-
A – 5 (20) / unit
B – 3 (25) / unit
Direct cost – 40/unit
Fixed cost – 1,000,00
Pls help to solve this
(i need both Absorption & Marginal(variable) costing
Help as Possiable
pls help the upper question
Hi experts Can u please please …. help me slove cost account problem
Big Ben company established new manufacturing unit of casual gents shirts: each shirt company sell at US$ 48 each, it coat variable cost to make 1 shirt US$ 21 each (such as materials, accessories, labor, ect), and cost US$ 68,000 per month fixed cost to run the factory (such as, salaries, rent, fixed overheard, ect). And company most like sell 3000 peace of shirts per month.
What is the gross margin per shirt
What is the total gross margin for shirts sold during the month
Hi can you help me solve this problem.? Prepare income statement under 1) absorption costing 2) marginal cisting
A clothing company has the following data which produced and sold T-shirts. Opening inventories if 500 T-shirts valued @$ 100,000 including variable cost of $80 per tshirt
Production. 5000 units
Sales at $300 per T-shirt. 400units
Direct material cost. $200,000
Direct labor cost. $100,000
Factory overhead
Variable cost. $100,000
Fixed costs. $600,000
Selling and distribution overheads
Variable cost. $20,000
Fixed cost. $30,000
Closing inventories is valued at current cist
Does variable costing always produces low amount of profit ?
Why is it the absorption costing method is used to report external and variable costing internal why plz help
why didn’t we compute v. Selling & admin. Costs in product cost under variable costing method ?
Don’t V. S&A costs change with production level so, we should have calculated them ? Or we only use it to determine contribution margin not product cost ?
This explanation is way more concise and approachable than that of my textbook. Thanks 🙂