Accounting variable and absorption costs

Variable costing vs Absorption costing

Variable and Absorption costing are two different methods and ways that many organizations use to determine and calculate product cost. The income statements formats of both methods include period and product costs. However, each one has a different cost classification definition. Both have the same direct material and direct labor allocation, the differences is how they report the income, product, and pricing

One of the main differences between the two methods is the accounting for the fixed manufacturing costs. In variable costing, fixed manufacturing costs are looked at as expenses of the period, while absorption costing the fixed manufacturing costs are treated as inventory costs. Because fixed manufacturing costs are not included in the inventory product costs under variable costing, the inventory value is a lot less. Meaning, the value of inventory is understated in variable costing. In absorption costing, the value of inventory is overstated because product costs are inflated by the fixed manufacturing costs. The reason why this is a big difference is because there is a link between the value of inventory and the net income of a period. The profit of a company increases as the size of an asset increases because inventor is a current asset.

Another difference is the pricing. However, because there is a difference in the pricing products, many companies who use the variable costing method often think they can price their products for a lower cost than those who use the absorption costing method. This is wrong because reducing the final selling price will result in a lower than normal net income because fixed manufacturing overhead is counted as a period cost on the income statement. In the absorption costing method, there is a more accurate and definite pricing because they include manufacturing overhead, both fixed and variable, which allows the company to come up with a better estimate of a