Question

When making management decisions, is variable or absorption costing more efficient and what are the reasons it is more efficient?

Answer 1

"Variable costing" is an accounting decision-making tool to the management, utilized for internal reporting purposes. As opposed to "absorption costing," which is a system that considers all manufacturing costs for reporting purposes, Variable costing is more effective for decision making because this method excludes fixed overhead costs of goods sold.

Where as, Absorption costing meets the requirements of U.S. GAAP, but is not as useful for internal decision-making purposes.

• Absorption costing includes all costs, including fixed costs, related to production, while variable costing only includes the variable costs directly incurred in production which helps the management to make decisions more efficiently.
• Variable costing provides management with the information necessary to prepare a contribution margin income statement, which leads to more effective cost-volume-profit (CVP) analysis.
• By separating variable and fixed costs, management are able to determine contribution margin ratios, break-even points, and target profit points, and to perform sensitivity analysis.
• Variable costing internally is that it prevents management from increasing production solely for the purpose of inflating profit.
• Variable costing compare the potential profitability of different product lines. It is easier to discern the differences in profits from producing one item over another by looking solely at the variable costs directly related to production.