Explain the differences between absorption costing and variable costing.
Explain, with the help of an example, how a company could use a variable costing system, as well as an absorption costing system. You have the option of using the company you work for as an example.
Explain which method is better for the company being discussed.
Absorption costing and variable costing are different in a few ways. However, even though they are different most all companies use the both types of methods. Each system has benefits and boundaries. Variable costing is also known as direct costing or marginal costing and absorption costing is often referred to as traditional costing or full costing. Absorption costing is a method where you apply part of the fixed overhead to the cost of manufacturing products (Johnston, 2014). The cost of absorption costing is done on a per-unit basis. This is calculated by dividing the fixed costs by the number of units manufactured and sold in the period (Johnston, 2014). Variable costing is a method where fixed overhead is a lump sum and not a per-unit expense. However, this method includes all variable costs like raw materials, shipping and supplies. The addition of fixed overhead is included for this period too (smallbusiness.chron). You need to subtract the per-unit expenses from the revenue as a total expense. As noted above, the absorption costing is used to allocate overheads to a job to define the cost of production. Fro example, lets say a factory has a job where it produces a product in one location. The direct materials for the job are 15,000, the direct labor was 7,500 and the direct labor hours were 100. Let’s say thee total overheads were 60,000 and the labor hours were 10,000, so the overhead would be the 60,000 divided by 10,000 and then multiply by the hours spent on this particular job (100 hours) for an overhead of $600. We then must add this 600 to the direct cost for a total production of 15,000+7,500+600 = 23,100. The ABC method argued that changes in the business environment such as reductions in labor cost may invalidate absorption costing assumptions, even though the errors may be in the use of absorption costing information designed for financial accounting purposes used for making decisions (Ifandoudas & Gurd, 2010).
An example of variable costing can be found in the textbook with the use of Weber Light Aircraft. The variable production cost per unit is 25,000 with the inclusion of direct materials, labor and overhead. Since the monthly cost per aircraft is 25,000 the costs for each month can be easily calculated by multiplying the production cost (25,000) by the number
