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The Variable Costing
method (also: Direct Costing or Marginal costing) is an
inventory valuation / costing model that includes only the variable
manufacturing costs:
-
direct materials (those materials that become an integral part of a
finished product and can be conveniently traced into it)
- direct labor (those factory labor costs
that can be easily traced to individual units of product. Also called
touch labor)
- only variable manufacturing
overhead
in the cost of a unit of product. The
entire amount of fixed costs are expenses in the year incurred.
Variable Costing is also referred to as
the direct costing method or the marginal costing method.
Should Fixed Manufacturing Costs be Included in Inventories?
Advocates of Absorption Costing say it should, because all of the
production costs are needed to create the products. Thus, they have
"future economic benefits."
Advocates of Variable Costing argue that in order for a fixed
manufacturing cost to be an asset, it has to meet a "future cost
avoidance" criteria much the same way as prepaid insurance. In the case
of fixed manufacturing costs, they do not meet this criteria because
they are incurred each time the production line opens. Thus, they need
to be expenses in that period and only variance expenses inventoried.
Consequences of using Variable Costing for Profit calculation
The difference is important for calculating profit when a beginning and
ending inventory levels are different:
- If beginning & ending inventory levels are equal: absorption costing
profit = variable costing profit;
- If inventory levels are run down over the period: variable costing
profit will be higher than absorption costing profit;
- If inventory levels are increased over the period: absorption costing
profit will be higher than variable costing profit.
Compare with Variable Costing: Absorption
Costing | Activity Based
Costing
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