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