PRESENTATION ON ABSORPTION AND

VARIABLE COSTING
INTRODUCTION
 Income statements are prepared to assess profitability.
 I.S are used for decision making by the

• Internal parties
• External parties
 The costs of producing goods or providing services are
collected, classified and analyzed before analyzing I.S
 Two methods

• Absorption (External D.M)

• Variable (Internal D.M)
 Objectives differs
PRODUCT VS PERIOD COST
Product cost
• included in regarding the
production of goods
• Includes direct materials,
direct labour and
manufacturing overhead
• Variable cost
• Cost is in cast per unit
Period cost
•Not used in the valuation of
inventory
•Not necessary part of the
manufacturing process
•Both fixed and variable cost
•Variable cost is in per unit
ABSORPTION COSTING

 Also known as Traditional or Full cost concept

 includes both fixed and variable costs
 Consists all cost necessary for production
 All costs are identified with the manufactures
products.
 Used for external reporting purpose
VARIABLE CONCEPT
 Also known as s direct costing or a marginal
costing
 Fixed manufacturing overhead and variable
selling and administrative overhead are
considered as period cost
 Whereas direct material, direct labor and
variable manufacturing overhead are
consideres as product cost
 Helps in decision making process

 Helps in preparing income statement

FEATURES
 Costs are separated into fixed and variable
 Fixed costs of the organization are period cost

 If sales unit is higher than production unit the profit of

variable costing will be higher than absorption costing
 Profit is determined by deducting variable cost and fixed
cost from sales
IMPORTANCE
 evaluate the performance of different department.
 appropriate technique for managerial decision making.

 Break-Even analysis totally based upon variable costing.

 For standard costing and budgeting , variables costing is

the valuable principal.
LIMITATION OF VARIABLE COSTING

 No variable cost is completely variable and no fixed

cost is completely fixed.
 Fixed manufacturing overhead are not included in the
valuation of work progress, losses may occur every year.
 DIFFERENCE BETWEEN ABSORPTION AND
VARIABLE COSTING
Basics of Differences Absorption costing Variable costing

Fixed manufacturing Considered as product cost Cosidered as period cost

overhead

Inventory Value of inventory is higher Value of invnetory is lower

Profit Higher ending inventory, Lower ending inventory,

higher profit lower profit

Reporting purpose External reporting Internal reporting

Over or under absorption Over or Under absorption of won’t be over or under

fixed manufacturing absorption of fixed
manufacturing
RECONCILIATION
 Profit shown by an absorption and variable costing
might differ.
 Difference does not exist if the production and sales
units are equal but if there are differences the net profit
will differ.
 Difference is the inclusion of FMOH in absorption but
not in variable costing.
 Useful tools for both internal and external auditors
Thank you