See Also:
Absorption vs Variable Costing
Standard Costing System
Standard Costing Example
Process Costing
Activity Based Costing
Absorption vs Variable Costing Advantages and Disadvantages
The following includes absorption vs variable costing advantages and disadvantages.
Variable Costing Disadvantages and Advantages
Variable costing may provide a clearer picture of the actual incremental costs associated with a specific product. Essentially, the variable costing method can give those concerned with financial records an accurate representation of what actually goes into the costs of producing. Proponents of variable costing argue that fixed manufacturing overhead costs are incurred regardless of production volume. Therefore, they should not be considered in product-related decision-making. Therefore, variable costing method users can enjoy a reported cost that is representative of the actual inputs to the products. However, by ignoring fixed manufacturing overhead costs, variable costing may understate a product’s overall cost. The manufacturing overhead is important. This is because, though the costs included in overhead do not contribute directly to the creation of the product, there is still some residual effect on the production which drives up the cost to produce.
Absorption Costing Disadvantages and Advantages
In contrast to the variable costing method, absorption costing may provide a fuller picture of a product’s cost by including fixed manufacturing overhead costs. A proponent of this method would argue that it is most effective. This is because, simply enough, all the possible costs are included. This method gives a company or organization a more accurate view of the products importance from an economic standpoint.
If the product is turning over a good amount of revenue in the absorption costing method, then it is turning over revenue in addition to the unrelated costs of production. However, absorption costing ignores the differential usage of indirect resources across products or product lines. Also, you can use absorption costing as an accounting trick to increase net income by moving fixed manufacturing overhead costs from the income statement to the balance sheet. Do this by simply increasing production volume disproportionately to sales volume.
Absorption Costing GAAP
GAAP requires absorption costing for external reporting.
