Variable Costing

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What is Variable Costing? Description

The variable costing method is an inventory valuation/costing model, that includes only the variable manufacturing costs in the cost of a unit of product. It is also called: direct costing or marginal costing.

Variable manufacturing costs are

  • Direct materials. Those materials that become an integral part of a finished product and can be conveniently traced into it.
  • Direct labor. Those factory labor costs that can be easily traced into individual units of product. Also called: touch labor.
  • Only variable manufacturing overhead costs are included.

The entire amount of fixed costs are expenses in the year incurred.

Variable Costing is also referred to as the Direct Costing method or the Marginal Costing method.

Should Fixed Manufacturing Costs be Included in Inventories?

  • Advocates of Absorption Costing say that it should, because all of the production costs are needed to create the products. Thus, they have "future economic benefits."
  • Advocates of Variable Costing argue that in order for fixed manufacturing costs to be an asset, it has to meet a "future cost avoidance" criteria. Much in the same way as prepaid insurance. In the case of fixed manufacturing costs, they do not meet this criteria because they are incurred each time the production line opens. Thus, they need to be expenses in that period. Only variance expenses are inventoried.

Consequences of using Variable Costing for Profit calculation

The difference is important for calculating profit when the beginning and ending inventory levels are different.

  1. If beginning & ending inventory levels are equal: absorption costing profit = variable costing profit.
  2. If inventory levels are run down over the period: variable costing profit will be higher than absorption costing profit.
  3. If inventory levels are increased over the period: absorption costing profit will be higher than variable costing profit.

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Information Sources

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Absorption versus Marginal Costing

Accounting, Controlling, Budgeting
Presentation that compares Absorption Costing with Marginal Costing, thereby explaining the concept of both methods in d...

Incentives for Effcient Inventory Management: The Role of Historical Cost

Historical Cost Accounting, Inventory Management
Paper by Tim Baldenius and Stefan Reichelstein examines inventory management from an incentive and control perspective. ...

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Compare with Variable Costing: Absorption Costing  |  Activity Based Costing

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