Variable costing

Definition

Variable costing is an accounting method that only considers variable costs when calculating the cost of goods sold and inventory. Unlike absorption costing, which includes both fixed and variable manufacturing costs, variable costing focuses on the costs that change with production levels. This method provides insight into how production levels affect overall profitability, especially in contexts involving joint products and by-products, where costs and revenues can become complex.

5 Must Know Facts For Your Next Test

1. Variable costing is often used for internal decision-making as it provides clearer insights into how costs behave with changes in production levels.
2. Under variable costing, fixed manufacturing overhead is treated as a period expense and is not included in inventory values, which can affect financial statements differently than absorption costing.
3. In scenarios with joint products, variable costing helps determine the profitability of each product after the split-off point by analyzing their respective variable costs.
4. By-products can be accounted for using variable costing by recognizing their sales value separately from the main product's revenue, often simplifying accounting treatment.
5. Variable costing is also beneficial for break-even analysis since it focuses solely on variable costs and can help managers understand the impact of different production volumes.

Review Questions

• How does variable costing impact the assessment of joint products after the split-off point?
  • Variable costing impacts the assessment of joint products after the split-off point by allowing managers to focus solely on the variable costs associated with each product. This helps in determining each product's profitability since only those costs that directly change with production are considered. By doing so, managers can make more informed decisions regarding pricing, production levels, and resource allocation for each joint product.
• Discuss the advantages and disadvantages of using variable costing in contrast to absorption costing within a company.
  • The advantages of using variable costing include clearer insights into cost behavior and enhanced decision-making regarding pricing and production levels, as it emphasizes the relationship between costs and volume. However, one disadvantage is that it can result in lower reported profits during periods of high inventory buildup because fixed manufacturing overhead is expensed immediately. Absorption costing may provide a more favorable view of profitability during such times but can obscure true cost dynamics related to production changes.
• Evaluate how variable costing influences management decisions related to by-products in manufacturing processes.
  • Variable costing influences management decisions related to by-products by providing a framework that separates their economic value from the main product's revenue. Since by-products usually generate lower sales values, understanding their cost structure under variable costing helps managers decide whether to sell them or invest resources elsewhere. This clarity allows for better optimization of resource allocation and ensures that decisions are made based on a comprehensive understanding of profitability across all products generated during production.

Related terms

Absorption Costing: A costing method that includes all manufacturing costs, both variable and fixed, in the cost of a product.

Joint Products: Products that are simultaneously produced from the same raw materials or processes, often leading to shared costs until a split-off point.

By-Products: Secondary products generated during the manufacturing process of a primary product, usually with lower economic value.