Treatment of inventory costs and period costs

Absorption costing: Under the absorption costing approach, products "consume" all manufacturing costs (both fixed and variable). That is, all manufacturing costs are expensed as inventory costs (Cost of Goods Sold). Administrative and selling costs (both fixed and variable) are expensed as period costs. Thus, absorption costing reflects the idea that product (i.e. manufacturing) and non-product (i.e. period) costs should be distinguished on the financial statements while it makes no distinction between fixed and variable costs. Variable costing: On the other hand, under variable costing approach, product and period costs are divided into two groups: variable and fixed costs. Variable costing approach treats all variable costs as inventory costs and all fixed costs as period costs. Throughput costing: Finally, under throughput costing, only direct materials are recorded as inventory costs while all other manufacturing costs (including direct labor and variable factory overhead) are expensed as period costs. Selling and administrative costs are expensed as period costs as well. The comparison of the absorption, variable, and throughput costing methods is summarized in the table below: Absorption Costing GAAP Variable Costing Not GAAP Throughput Costing Not GAAP

External Reporting Internal Reporting Used to save costs

Inventory costs

Direct materials Direct labor Variable overhead Fixed overhead

Used to evaluate Used for short-term performance and for capacity decisions decision making Direct materials Direct materials Direct labor Variable overhead Variable SG&A expenses* Fixed overhead Fixed SG&A expenses

Period costs (expensed when incurred)

SG&A expenses

Direct labor Variable overhead Fixed overhead SG&A expenses