Summary There are two types of costing methods and they are absorption and variable costing methods and they refer to the way in which product costs are determined. Absorption costing is a method that aims to include all expenses including overheads in the calculation of the cost of producing goods or services and variable costing treats fixed factory overhead as a period expense. These variable costs consist of direct materials, direct labor, and variable factory overhead. Most companies use absorption and variable costing together, both of the systems have their own benefits and limitations.
Absorption Costing * According to Mowen & Heitger chapter 8, “absorption costing uses fixed factory overhead as a product cost. Unit product cost consists of direct materials, direct labor, variable factory overhead, and fixed factory overhead.” Companies may use absorption costing if they want to gain a full understanding of the extent to which costs are covered by sales income. An absorption cost is required for external reporting and is a general accepted accounting principle that the Internal Revenue Service will accept. * Variable Costing * Variable costing treats fixed factory overhead as a period expense. Unit product cost consists of direct materials, direct labor, and variable factory overhead. Variable costing provides a better understanding of the effect of fixed costs on the net profits because total fixed cost for the period is shown on the income statement. The variable costing can also give a figure of cash flow or supply vital cost information for decision making or provide information not supplied by absorption costing. Variable
