Variable Costing vs Absorption Costing

Difference Between Variable and Absorption Costing

Variable cost is the accounting method in which all the variable production costs are only included in product cost whereas Absorption costing is where all the absorbed costs are taken into account and under this method, all the fixed and variable production costs are deducted and then fixed and variable selling expenses are deducted.

Variable costing is defined as an accounting method for production expenses where only variable costs are included in the product cost, whereas, Absorption costingAbsorption CostingAbsorption costing is one of approach which is used for the purpose of valuation of inventory or calculation of the cost of the product in the company where all the expenses incurred by the company are taken into the consideration i.e., it includes all the direct and indirect expenses incurred by the company during the specific period.read more includes all costs associated with a production process that is assigned to the units produced.

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Variable vs Absorption Costing Infographics

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Key Differences

It is important to gauge the key differences between these costing. This will give us additional clarity on the subject matter.

Variable vs Absorption Costing Comparative Table

BasisVariable CostingAbsorption Costing
CostsVariable costing includes only variable costs directly incurred in production.Absorption costing includes both variable costs and fixed costsFixed CostsFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity.read more related to production.
Alternative NamesVariable costing is also known as marginal costing or direct costing.Absorption costing is also known as full costing.
Internal / External UseVariable costing is generally used for internal reporting purposes. Managerial decisions are taken on the basis of variable costing.Absorption costing is used for reporting to the external stakeholders as well as for the purpose of filing taxes. It is in line with GAAPGAAPGenerally accepted accounting principles (GAAP) are the minimum standards and uniform guidelines for the accounting and reporting. These standards prohibit firms from engaging in unethical business activities and enable for a more accurate comparison of financial reports to investors.read more (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards).
RelevanceVariable costing is used for comparing the profitability of different product linesDifferent Product LinesProduct Line refers to the collection of related products that are marketed under a single brand, which may be the flagship brand for the concerned company. Typically, companies extend their product offerings by adding new variants to the existing products with the expectation that the existing consumers will buy products from the brands that they are already purchasing.read more. The organization can carry out an analysis based on costs, volumes, and profits.Absorption costing is used for calculating per unit cost based on all costs including fixed overhead costs.
ReportingVariable costing is based on internal specifications of reporting and presentation.Absorption costing is based on external reporting standards given by external agencies.
InventoryVariable costing involves only variable production costs to be assigned to inventory, work-in-progress, and cost of goods sold.Absorption costing involves considering all production costs and including them in inventory and work-in-progress.
ContributionVariable costing calculates contribution which is the difference between sales and variable cost of sales.Absorption costing is used to calculate the net profit.
ProfitProfit is much easier to predict as it is a function of sales.It is much more difficult to predict the effect of change in sales on profit.

Conclusion

Though variable costing aids in managerial decisions, it should not be the sole basis for managerial decisions. The management should look at different perspectives including looking at absorption costing data. The management should look at consumer insights, relation with buyers, the effect on brand-building, and other factors while taking decisions. While calculating net profit, a manager should look at both costing techniques.

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