Question

Two important cost methods - variable costing and absorption costing (also called full costing). Because full costing is accepted for financial reporting purposes and variable costing is not, why should we be concerned about the difference between them? What is the difference, and why is it important?

Answer 1

Absorption costing includes all costs related to production, including fixed costs while variable costing only includes the variable costs directly incurred in production. Companies which use variable costing keep fixed-cost operating expenses separate. The fixed cost that differentiate absorption and variable costing are overhead expenses such as salaries, rent which do not change with the production level.

While absorption costing is the method required to be in compliance with GAAP. Absorption costing is required to calculate taxes and is required by law when it publishes its financial statements.

Absorption costing gives a more accurate accounting of net profitability where every expense is allocated to products manufactured when sold or not. Variable costing on other hand can make the ideal pricing of goods difficult since it does not cover all the costs.