Question

You have just taken a job at a manufacturing company and have discovered that they use absorption costing to analyze product costs and subsequent cost-volume-profit decisions. You would like to introduce them to variable costing and explain to them why this costing method can be used and why it is helpful.

Compose a short email - 2 to 3 short paragraphs because the president it too busy to read anything longer than that - proposing a variable costing system and what that might mean for reports, analysis and comparisons. You could give a brief example if you feel that is necessary for your explanation to the president.

Answer 1

answer-

Absorption costing is a method whereby you apply part of your fixed overhead costs to the cost of manufacturing products. You do this on a per-unit basis. Simply divide your fixed costs by the number of units you manufactured and sold during the period. while Variable costing uses fixed overhead as a lump sum, rather than a per-unit, expense. Under this method, you include all your variable costs such as supplies, raw materials and shipping. You add the full cost of fixed overhead for the period. You do not figure these expenses on a per-unit basis. Instead you subtract them from your revenue figure as a lump-sum expense.

variable costing is very helpful because Variable costing shows your profits after all the bills have been paid for the accounting period. Though you may not have received revenues for the products you manufactured because some could be in inventory, you show that you have paid all of your expenses for the period. When you finally sell the finished products in inventory, you have surplus income.

the absorption method is not very helpful because Absorption costing can artificially inflate your profit figures in any given accounting period. Because you will not deduct all of your fixed overhead if you haven't sold all of your manufactured products, your profit-and-loss statement does not show the full expenses you had for the period. This can mislead you when you are analyzing your profitability.