Absorption costing and variable costing are costing methods that emphasize the treatment of fixed costs when valuing products. Here is an introduction to these costing models, but first a brief definition of the cost systems:
Cost systems
According to Faga (p.15), the cost systems are the various ways that can be used to achieve an adequate valuation of the products in each of the stages of the operation, with special emphasis on the production process. One of the fundamental categories of cost systems is made up of those methods that highlight the treatment of fixed costs at the time of valuing products, this category includes absorption costing and variable costing.
Costing by absorption
The absorption or total costing theory contemplates that the determination of the cost of production of goods, services or activities is composed only of the direct or operating costs and the indirect costs of the processes, cost centers or productive areas of responsibility. According to this theory, production costs -direct and indirect- affect profits for the period depending solely on the quantity of goods or products produced and sold, or services rendered and invoiced during the period. (Aguirre, p.35)
Variable costing
The theory of direct, variable or marginal costing initially considers that the cost of production of goods or services should only assume the direct costs caused in their production, and additionally contemplates that the cost of sales of the good or service should include all the direct distribution, marketing, market and / or sales expenses fully identified, in order to determine the total direct cost of the economic good, which allows obtaining a more reasonable profit margin per product or service than that calculated under the absorption costing theory. Under conditions of normal development of a company, that is, the production volume is greater than the number of units sold and the unit balances at the end of the accounting period are also greater than the initial balances,This economic theory results in lower profits, since the indirect costs of production caused in the period affect the results of the same in its entirety, regardless of the number of units produced and sold or services provided and invoiced, as it is presented in the theory of the absorption costing. (Aguirre, p.36)
While Jiménez and Espinoza (p.50) explain that it is a costing method that considers only the variable manufacturing costs (material, labor and indirect) as the costs of the inventoried product. In addition, it separates the costs of the income statement into variable and fixed. In general, variable production costs are the direct material cost, the direct labor cost and a part of the indirect manufacturing costs as indirect material. electrical energy, fuels and lubricants. As fixed costs, indirect labor, plant rent, straight-line depreciation, lighting, among others. Variable costing considers fixed indirect production expenses as a period cost that must be immediately charged to the income statement,rather than being a cost of the product that is held as inventory and later expensed as part of the cost of the merchandise sold under absorbing costing. These authors teach the following example of income statement by the variable method:
Example of an income statement for variable costing (Jiménez and Espinoza, p.51)
Berrío and Castrillón (pp. 44-46) make an excellent synthesis that addresses the advantages, disadvantages and differences of the absorption and variable costing methods, they are cited below:
Advantages of variable costing
- Eliminates fluctuations in costs due to the effect of different production volumes Facilitates the elaboration of the cash budget, since variable costs usually imply disbursements The fact of not including fixed indirect costs in the product cost and showing this Value in isolation allows better control of fixed costs, since they can be compared from one period to another independent of production Profits for variable costing depend on sales, while in the total costing system more profits are shown just for the sake of producing. It is logical that profits are correlated with sales and not with production.The presentation of the income statement under the variable costing system makes it easier for management to control costs and make decisions,based on the criterion of contribution margin or marginal analysis. Such decisions could be:
- Determine the optimal composition of production when there is a scarce resource Set sales prices to special orders Produce or buy Set prices to export sales Analyze the profitability of products or product lines Use marginal analysis to decide on new ones Capital investments. In Responsibility Center accounting, variable costing is very useful for evaluating administrative management.
Disadvantages of variable costing
- The separation of costs into variable and fixed is a difficult task. If it is not done carefully, it generates errors in the valuation of inventories and, consequently, in the determination of profit. It is not yet accepted for official reports, which implies carrying double information: one for external users and another for internal users When sales are seasonal, periods of high losses are followed by periods of high profits, which baffles any user of the information.
Differences
- The variable costing system considers fixed production costs as period costs, while total costing distributes them among the units produced.To value inventories, variable costing only considers variable disbursements, total costing includes fixed and variable The profits in one or the other system vary when there are changes in inventories, due to the capitalization or not of fixed costs.
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In the next video lesson Professor Jorge Ignacio Lardizábal teaches us and explains the two concepts, absorption costing and variable costing, it will surely be useful to expand your understanding of the two methods.
Bibliography
- Aguirre Flórez, José Gabriel. Costing system. Jorge Tadeo Lozano University, 2004.Berrío Guzmán, Deysi and Castrillón Cifuentes, Jaime. Costs to manage manufacturing, commercial and service organizations. Universidad del Norte, 2008. Faga, Héctor Alberto. How to deepen the analysis of your costs to take better business. Ediciones Granica, 2006. Jiménez Boulanger, Francisco Javier and Espinoza Gutiérrez, Carlos Luis. Industrial costs. Technological Publishing House of Costa Rica, 2007.
