Explain the difference between variable and absorption costing

Variable and absorption costing are usually two different costing methods. Most successful companies on earth use both the techniques. Variable costing and absorption costing are not substituted for the other person because both your systems have their unique benefits and constraints.

These costing solutions are known through various names. As an example, variable costing is also referred to as direct costing or even marginal costing and absorption costing is also referred to as full costing or even 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 certainly used by internal management along with by external events like creditors, federal agencies and auditors for example.

Calculation of unit product cost under two systems:

Under absorption costing system, the product cost consists of all variable as well as all fixed production costs i. age., direct materials, primary labor and factory overhead (FOH). But when variable costing system is employed, the fixed cost (both manufacturing as well as non-manufacturing) is treated being a period or capacity cost and is, therefore, not within the product cost.

Following exhibition summarizes the difference between variable costing and 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:



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

Sunrise 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 2010 is given below:



Required: Compute unite product cost under variable costing and absorption costing.




Marketing and administrative expenses are period costs and are not relevant in the computation of unit product cost