Management accounting is one of accounting branches which provides accounting information to the management in order to make decisions. It is therefore, important to ensure that the information that is disseminated through management accounting is relevant and reliable by the management in order for right decisions to be taken (International Financial Reporting Group, 2012). In order to achieve all this, an organization ought to ensure that the costs are managed well. There are two main ways of costs classification: absorption costing and variable costing. Product costing is an important aspect of any company which seeks to control its costs and also to make other decisions such as pricing of their products. Therefore, product costing is essential in aiding the decisions of the management (International Financial Reporting Group, 2012). These are two distinct costing methods that are going to be discussed in the ensuing text.
Differences between absorption and variable costing
The main difference between absorption costing and variable costing is that under the absorption costing, a product’s cost consists of all the variable costs as well as all fixed manufacturing costs associated with the product, while under variable costing, the product’s cost does not include the manufacturing and the non-manufacturing fixed costs (Subramani, 2009). It is therefore, important to note that a product’s cost ought to be classified into various distinct components such as the direct costs, variable costs, fixed overheads, and variable overheads.
|Variable manufacturing cost||$400.00|
|Total unit cost||$2,850.00|
Under absorption costing, as indicated in the above calculation, it can be seen that the cost of producing one unit of the products is arrived at after adding all the direct costs as well as allocating the variable and the fixed overheads associated to the production of the particular product.
|Variable manufacturing cost||$400.00|
|Total unit cost||$2,600.00|
Under variable costing, the cost of a product only includes the direct cost associated with the product as well as the variable cost per unit. However, the fixed costs associated with the production of the product is never used to calculate the unit cost of the product (Richard & Devinney, 2009). This therefore, forms the major difference between the absorption costing and variable costing methods.
The components of unit cost would be different when treated in both cases due to the omission of the fixed variable costs when determining the unit cost under variable cost (William & MIlton, 1999). Under the example used above, the unit cost under absorption costing is $2,850.00. This is arrived at after adding the direct labor, direct materials, variable manufacturing costs, fixed manufacturing costs and fixed SG&A costs (Clyde, 2010). These all costs add up to $2,850.00. Under the variable costing, the unit cost of the product is arrived at after adding the direct labor, direct materials and variable overheads. This adds up to $2,600.00. It is evident that the treatment of unit costs under the two costing methods results in two different units costs (International Financial Reporting Group, 2012). There are other various aspects of absorption costing that distinguish variable from absorption. For instance, absorption costing does not support the cost volume profit analysis because the fixed costs are included in the cost of production (Richard & Devinney, 2009).
Clyde, P. S. (2010). Financial accounting : An Introduction to Concepts, Methods, and Uses. Mason: Cengage Learning.
International Financial Reporting Group. (2012). International GAAP 2012 : Generally Accepted Accounting Practice under International Financial Reporting Standards. Chichester: John Wiley & Sons.
Richard, P., & Devinney, T. (2009). Measuring Organisational Performance: Towards Methodological Best Practices. Journal of Management, 718-804.
Subramani, R. (2009). Accouting for equities, futures and options. New York: John Wiley & Sons.
William, K., & MIlton, F. (1999). Cost Accounting. Houston : Dame Publications.