Quiz 8: Variable Costing and the Costs of Quality and Sustainability

Business

Absorption (Full) costing: Absorption costing is a method of 'inventory costing' in which the total costs viz., fixed manufacturing costs as well as variable manufacturing costs, both are included a inventoried costs, both are included as inventoried costs. Under this costing, fixed overhead is applied to manufactured goods as a product cost. The fixed overhead cost remains in inventory until the goods are sold. Variable (Direct) costing: Variable costing, also known as 'direct costing' is a method of inventory in which only all variable costs are included as inventoried costs, all fixed costs are excluded and treated as period costs, i.e., the costs of the period in which they are incurred. If may be noted that both these methods i.e., Absorption costing and variable costing are the methods used for costing the inventories in manufacturing companies. The basic difference between these two methods is none of conceptual in nature i.e., Whether fixed costs, both, direct and indirect are inventoried costs are inventoried costs. Because under both the methods, the non-manufacturing costs such as research and development, marketing etc. whether fixed or variable, are recorded as expenses when incurred. The only discrimination is about the "fixed manufacturing costs", with 'timing' being the key factor for the difference. The differences between the absorption costing and the variable costing are presented in the following table. img

Yes, timing is the key or important basis for distinguishing between absorption costing and variable costing. The discrepancies between absorption-costing and variable costing income occur because of the changes in inventory levels during the particular period. So it is common for production and sales to differ over the course of a week. Under both the product costing system, the fixed over-heads are attached to the products. However, under variable costing, they are expenses immediately, as they are incurred. But, under absorption costing, fixed overheads are inventories until the accounting period during which the manufactured goods are sold. A portion of the fixed costs is carried forward to the next period because the closing stock of work-in-process and finished goods is valued at cost of production which is inclusive of fixed costs. Actually the fixed costs are period costs and should be charged to the period in which they are incurred and not be carried over to the next period. This is done under variable costing and not in absorption costing Thus, the 'timing' is the key distinguishing feature between absorption costing and Variable Costing.

The term variable costing vs. direct costing: Yes, I do agree. The term 'Direct Costing' is a misnomer and 'Variable Costing' is a better term for the product-costing method. Generally, both these terms viz., 'Direct Costing' and 'Variable Costing' are used interchangeably. However, the term 'Variable Costing' is a better choice than 'Direct Costing' because; 1). Variable costing does not include all direct costs as inventoriable costs. Only direct variable manufacturing costs are included. The direct fixed manufacturing costs and direct nonmanufacturing costs are excluded form inventoriable costs. 2). the inventory costs under 'variable costing' include not only direct manufacturing costs but also some indirect costs.