Difference Between Absorption Costing And Variable Costing.Absorption costing (also called “full costing”) is the method derived from the application of the Fundamental Accounting Principles. This method was derived from the system developed in Germany in the early 20th century known as RKW (Reichskuratorium für Wirtschaftlichtkeit).
Example:
Assuming the following costs for producing XYZ, using the absorption system method, we have:
| DESCRIPTION | PRICE R$ |
| Raw materials transferred to production | 25,000.00 |
| Cost of Production Labor calculated in the month | 10,000.00 |
| General Production Expenses calculated in the month | 8,000.00 |
| TOTAL MONTHLY PRODUCTION COST | 43,000.00 |
| Units Produced in the month | 5,000 |
| Unit Cost of XYZ Production | 8.60 |
Difference Between Absorption Costing And Variable Costing.
Absorption costing and variable costing are two methods used in managerial accounting to calculate the cost of producing a product. The main difference between these two methods is how they treat fixed manufacturing overhead costs.
Absorption Costing: Absorption costing is also known as full costing or traditional costing. This method includes all the costs involved in producing a product, including direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead. Fixed manufacturing overhead includes expenses such as rent, utilities, and depreciation that do not vary with changes in production levels.
In absorption costing, fixed manufacturing overhead is absorbed by the products produced and included in the cost of goods sold. The cost of goods sold is calculated as follows: Total manufacturing costs (direct materials, direct labor, variable overhead, and fixed overhead) + Beginning inventory – Ending inventory = Cost of goods sold.
Variable Costing: Variable costing is also known as direct costing or marginal costing. This method only includes variable costs, which are costs that vary with changes in production levels, such as direct materials, direct labor, and variable overhead. Fixed manufacturing overhead is considered a period cost and is not included in the cost of goods sold. Instead, it is expensed in the period it is incurred. The cost of goods sold is calculated as follows: Variable manufacturing costs (direct materials, direct labor, and variable overhead) + Beginning inventory – Ending inventory = Cost of goods sold
Key Differences:
- Under absorption costing, fixed manufacturing overhead is included in the cost of goods sold, while under variable costing, it is considered a period cost and not included in the cost of goods sold.
- Absorption costing is required by generally accepted accounting principles (GAAP) for external financial reporting, while variable costing is not.
- Absorption costing provides a better measure of profitability in the long run, while variable costing provides a better measure of profitability in the short run.
- Absorption costing assigns a portion of fixed overhead costs to each unit of product, while variable costing only includes costs that vary with changes in production levels.
