Difference Between Absorption & Variable Costing Essay Example

all the required details. Firms employ different costing strategies to oversee their goods and services production. Both absorption and costing methodologies allow businesses to gain an in-depth understanding of their financial situation. Utilization of these techniques aids the company in considering factors like taxes, sales, stockpile of produced items, and organization-wide expenditure.

Both absorption and variable costing techniques provide companies with a more precise view of their financial performance. Absorption Costing, also known as full costing or the full absorption method, involves allocating all manufacturing costs to the products produced. This means that the price of each piece of finished inventory includes direct labor, direct materials, and variable and fixed manufacturing overhead. These costs encompass wages for workers, materials used in production, and overhead costs.

Absorption costing is utilized for external financial reporting and income tax reporting. It offers advantages and disadvantages. The advantage is that it provides the company with a clear understanding of the total cost of products, including fixed manufacturing and overhead. Accountants employ this method when preparing financial statements as it accurately recognizes the significance of fixed costs in production. Furthermore, absorption costing results in less fluctuation in net profits and distortion of stock evaluation.

The primary disadvantage of absorption costing is its lack of efficiency in management decision making, planning and control. Alternatively, variable costing correlates directly with the volume of production implying that as production levels rise or fall, so do variable costs. Examples of these fluctuating costs encompass direct material expenses, labor outlays directly linked to production and variable manufacturing overheads. These costs are inherent within the manufacturing process and invariably vary in line with

shifts in production volumes.

The variable cost figure does not include fixed costs like rent and management salaries. The company's costing method depends on multiple factors and both systems offer a better understanding of the production process and improve financial reporting to investors and financial institutions.