8/12/2019 Comparison Between Absorption and Variable Costing

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COMPARISON BETWEEN ABSORPTION AND VARIABLE COSTING

Their Impacts on profits

1. When Production equals sales

When production equals sale and the level of inventory doesnt increase or decrease, thelevel of profits under both methods will be the same, as there will be no overhead

carried forward in inventory

2.

When production exceed sales.

Absorption costing approach produces more profits when production is in excess of sales.

This is because of fixed production overhead that are include in the closing inventory

3. Sales exceed production

When sales exceed productions, more overheads are written off as expenses and therefore

the reduction in value of inventory. Variable costing profit will be less compared to

absorption costing profits. This results from decreased value of inventory, with fewer

inventories being deducted from cost.4. Impact of sales fluctuations

Under absorption costing system

Profit is the function of both production and sales volume. Therefore, profit is affected by

both production and sales volume (under/or over-recovery of overheads)

Variable/marginal costing system

Profit is the function of sales volume only. Profits under absorption system will increase

with the rise in volume of sales. While the fall in sales will result in decrease in profit.

Arguments in for Variable Costing

a) Variable costing provides more information for decision making

The use of variable costing where the costs are distinguished into fixed and variable

costs, enables the analysis of r elevant coststhus enabling the decision making

The decisions include

Relevant costs analysis

Product mix decisions

Purchasing and manufacturing decisions, whether to produce or purchase a

component externally

b) Helps to remove effect of inventory changes from profit