VARIABLE COSTING

MEMBERS

Asumbra, Bargues, Vingson, Sofia

Jesserene Danielle Marie Lorraine
Variable Costing
(Direct Costing)
is a method of recording and reporting costs which
regards only the variable manufacturing costs as
product costs. Fixed manufacturing costs are
written off as period costs.
 Underlying Concept
Proponents of this product costing method
maintain that the fixed part of factory overhead
is more closely related to the capacity to
produce than to the production of specific units
and therefore should be charged off as expense
in the period incurred. Furthermore, the use of
this system will permit construction of an
income statement which highlights the
contribution margin of the product and
therefore facilitates managerial decision-
making process.
It is contended that under this method, assets
(inventory) are being understated and that it is
not an accepted accounting practice.
Until variable costing becomes a generally
accepted accounting practice, companies who
wish to use it must convert inventory and cost
of goods sold figures to an absorption costing
basis for external reporting. This conversion is
a relatively simple process and is no deterrent
to the use of variable costing for internal
management purpose.
Advantages of Using Variable Costing
It meets the three objectives of
management control systems by
showing separately those costs that
can be traced to and controlled by
each strategic business unit (SBU)..
Net income using variable costing is not
affected by changes in inventory levels because
all fixed costs are deducted from income in the
period in which they occur. For this reason,
appraisal of performance of product line or other
segments of the business can be facilitated
without the need for arbitrary allocation of fixed
costs.
Cost-volume-profit relationship data needed for
profit planning purposes is readily obtained
from the regular accounting statements.
Analysis of costs relevant to pricing is likewise
simplified and enhanced. Variable costing ties in
with effective plans for cost control as standard
costs and flexible budget.
Disadvantages of Using Variable Costin

Variable costing may encourage a Variable costing may encourage a Variable costing may encourage a
shortsighted approach to profit shortsighted approach to profit shortsighted approach to profit
planning at the expense of the long- planning at the expense of the long-run planning at the expense of the
run situation. situation. long-run situation.
 Absorption Costing
(also known as full, traditional, conventional,
and normal costing)
Is a method of product costing in which all
manufacturing costs, fixed and variable, are treated
as product or inventoriable costs. This method is
generally accepted for external reporting purposes.
 Comparison between Variable Costing and
Absorption Costing
1.As to treatment of the
various operating costs:

It will be noted that it is

only in the treatment of
Fixed Factory Overhead
that two costing methods
differ. Under variable
costing, it is considered as
period cost while under
absorption costing, it is
treated as product cost.
 Comparison between Variable Costing and
Absorption Costing
2.As to net operating income
Net income is not affected by
changes in production under variable
costing. However, it is affected by
changes in production when
absorption costing is in use. Net
income goes up under the
absorption approach in response to
the increase in production for a
particular year and goes down when
production goes down. The reason
for this effect can be traced to the
shifting of fixed manufacturing cost
between periods under the
absorption costing method as
explained
 Comparison between Variable Costing and
Absorption Costing
a.When production volume
equals sales volume, net income
reported under absorption
costing and variable costing are
the same. The reason is that the
amount of fixed overhead
charged off to operations is the
same under each method and
also because there is no change
in the amount of fixed overhead
in the absorption inventory.
b.When production exceeds
sales volume, net income
reported under absorption
costing will be greater than that
under variable costing. This
result occurs because part of the
period’s production would go to
increase in inventory, and under
absorption costing, part of the
period’s fixed overhead would
be deferred along with it.
c.When sales exceed production
volume, net income reported under
absorption costing will be lesser
than that under variable costing.
Part of the period’s sales would
come from the beginning inventory,
which, under absorption costing,
carries with it a portion of the prior
period’s fixed overhead.
Comparison between Variable Costing and
Absorption Costing
3.As to amount of inventory
Inventory value under absorption costing
would be higher in amount than that
under variable costing. The inventory
amount would carry a portion of fixed
overhead incurred during the period
under the absorption costing.
 Reconciliation of Net Income under
Variable Costing with Net Income under
Absorption Costing
The reconciliation of the net income figures under
the two product costing methods may be done as
follows:
 Why Managers Prefer Direct Costing to
Absorption Costing
In Variable Costing:
• Only variable manufacturing costs are included in a unit’s product costs, and thus in the value of inventory of cost of
goods sold.
• Fixed manufacturing overhead is excluded and is it is reported as a separate expense and deducted from the
contribution margin along with fixed selling and administrative expense in determining operating income.

 Managers generally prefer Variable Costing because it separates fixed from variable costs as in cost-volume-profit
analysis. As a result, it is easier to compare actual operating income to planned operating income. With absorption
costing, actual operating income corresponds well with planned operating income only when inventory levels remain
unchanged. With variable costing, income is more closely associated with sales while absorption costing is influenced by
units produced and units sold.
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