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Assignment 8.1 Gerardo R. Cabrera
Assignment 8.1 Gerardo R. Cabrera
Assignment 8.1
Managerial Accounting
Absorption costing is a method of ‘inventory costing’ in which the total costs viz.,
fixed manufacturing costs as well as variable manufacturing costs, both are included a
inventoried costs, both are included as inventoried costs. Under this costing, fixed
overhead is applied to manufactured goods as a product cost. The fixed overhead cost
remains in inventory until the goods are sold.
On the other hand, variable costing, also known as ‘direct costing’ is a method of
inventory in which only all variable costs are included as inventoried costs, all fixed costs
are excluded and treated as period costs, i.e., the costs of the period in which they are
incurred. If may be noted that both these methods i.e., Absorption costing and variable
costing are the methods used for costing the inventories in manufacturing companies.
The basic difference between these two methods is none of conceptual in nature i.e.,
Whether fixed costs, both, direct and indirect are inventoried costs are inventoried
costs. Because under both the methods, the non-manufacturing costs such as research
and development, marketing etc. whether fixed or variable, are recorded as expenses
when incurred. The only discrimination is about the “fixed manufacturing costs”, with
‘timing’ being the key factor for the difference. The differences between the absorption
costing and the variable costing are presented in the following table.
Summarizing:
Absorption Costing
Variable Costing
1. Only variable costs are included fixed costs are recovered from the “Contribution”
2. Variable cost per unit remains the same at different levels of output, because
variable costs vary in the same proportion in which output varies.
3. Costs are classified according to the behavior of costs, fixed and variable costs.
4. Difference between sales and variable costs is the contribution towards fixed
costs and the difference between the contribution and fixed costs is either profit
or loss.
5. Cost, volume, profit (CVP) relationship is an integral part of variable costing.
6. The work-in-progress includes only variable costs and fixed costs are charged to
that period only in which they are included.
7. No over or under application of fixed overheads, because only variable costs
remain constant.
8–2. Timing is the key in distinguishing between absorption and variable costing.
Explain this statement.