The Differences Between Absorption Costing and Variable Costing

In cost accounting, absorption costing and variable costing are two commonly used methods for allocating costs to products or services. Understanding the differences between these two methods is essential for effective cost management and decision-making. Below are the key differences between absorption costing and variable costing:

Absorption Costing:

Absorption costing, also known as full costing, assigns all manufacturing overhead costs to products. This includes both variable and fixed manufacturing costs such as direct materials, direct labor, and factory overhead. As a result, absorption costing includes fixed manufacturing overhead costs in the cost of each unit produced.

Variable Costing:

Variable costing, on the other hand, only assigns variable manufacturing costs to products. Variable costs are costs that vary with the level of production, such as direct materials and direct labor. Fixed manufacturing overhead costs are treated as period expenses and are not included in the cost of goods sold.

Main Differences:

• Under absorption costing, fixed manufacturing overhead costs are included in the cost of goods sold, resulting in higher inventory valuations during periods of low production.
• Variable costing treats fixed manufacturing overhead costs as period expenses, leading to a more accurate reflection of the costs associated with producing goods.
• Income statements prepared using absorption costing may show higher profits in periods of high production compared to variable costing, due to the absorption of fixed overhead costs into inventory.
• Variable costing is often favored for internal decision-making and performance evaluation, as it provides a clearer picture of the costs directly associated with production.

It is important for businesses to carefully consider the implications of using absorption costing versus variable costing when determining product costs and evaluating overall performance.