Due in 24 hours 4-5 page assignment APA format Original work

Absorption costing: This is a costing system that treats all costs of production as the manufacturing costs that are absorbed by the units produced. In other words the cost of a finished unit in inventory will include direct materials, direct labor, fixed and variable manufacturing overheads. Therefore since absorption costing includes all costs of production as product costs; it is frequently referred to as full costing method.

Variable costing; this is a costing system which only considers those costs of production that vary with the output .this will usually include direct materials, direct labor and variable portion of manufacturing overhead. Sometimes this system is called direct costing or marginal costing.

The main difference between absorption costing and variable costing is that in absorption costing fixed manufacturing costs must be assigned to products to properly match revenues and costs while in variable costing, fixed manufacturing costs are capacity costs and will be incurred even if nothing is produced.

Example

A small company that produces a single product has the following cost structure

Number of units produced 6000

Variable cost per unit:

Direct materials $4

Direct labor $5

Variable manufacturing overhead $ 3

Variable selling and administration expenses $5

Fixed costs per year:

Fixed manufacturing overhead $20000

Fixed selling and administrative expenses $5000

Required

a. Compute the unit product cost under absorption costing method

b. Compute the unit product cost under variable costing method

Solution

Unit product cost

Absorption costing method

Direct materials $4

Direct labor $5

Variable manufacturing overhead $3

TOTAL variable production cost $12

Fixed manufacturing overhead $5

UNIT PRODUCT COST $17

Unit product cost

Variable costing method

Direct materials $4

Direct labor $5

Variable manufacturing overhead $3

UNIT PRODUCT COST $12

Under the absorption costing, all the production cost, variable and fixed is included when determining the unit production cost. Therefore this means that if the company sells a unit of product and absorption costing is being used then $17(consisting of $12 variable cost and $5 fixed cost) will be deducted on the income statement as cost of goods sold.

Under the Variable costing all the variable cost of production are included in product costs. Therefore this means that if the company sells a unit of product only $12 will be deducted as cost of goods sold.

Therefore given the above example I think variable costing is the better method because it is easier to estimate profitability of the products since the profits are not affected by changes in inventories.