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Variable vs Absorption Costing (Reasons for absorption costing…
Variable vs Absorption Costing
Variable Costing
Only variable costs used when finding unit cost (Contribution)
Fixed costs are period costs
Absorption Costing
All manufacturing costs used when finding unit cost (Gross profit)
Over/under absorption of O/H = O/H absorbed (from actual production) - overhead incurred (from budget production level)
Reasons for variable costing
Useful for short-term decision making
Easy to understand
Avoids arbitrary cost allocations
Removes the effect of inventory changes on profit
Avoids fixed overheads being capitalised in unsaleable inventories
Reasons for absorption costing
Theoretically superior
Production not possible without fixed costs so should be charged to products
Does not understate the importance of fixed costs
Useful for long-term decision making
Avoids fictitious losses
Consistency with external reporting