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BUS 630 week 3 DQ 2 Variable vs Absorption Costing

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Accounting

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BUS 630 week 3 DQ 2 Variable vs
Absorption Costing
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,

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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 therefor is
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
Variable
Costing
$5 $5

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$4 $4
$1 $1
$4* -
——- ——-
$14 $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.

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