What Is the Difference Between Absorption and Variable Costing?

What Is the Difference Between Absorption and Variable Costing?

Under the variable costing approach, fixed manufacturing costs such as direct labor and material costs are not included in the calculation of product costs, explains Accounting for Management. In contrast, absorption costing takes into account all fixed and variable costs when calculating product costs.

Absorption costing is also known as traditional costing or full costing while variable costing is also referred to as marginal costing or direct costing, explains Accounting for Management. Because they render differing results, the two costing approaches are not interchangeable. For this reason, a large number of companies use both methods to calculate costs and profits.

The results of the two methods are used in different ways. Corporate managers leverage the results of variable costing in internal decision-making processes. In contrast, information accruing from absorption costing is used by both corporate managers and stakeholders such as creditors and auditors.

Each costing method has its benefits and drawbacks, notes Kevin Johnston of Chron. Absorption costing tends to result in improved profitability because costs are calculated on a per-unit basis. Costs only show up on financial statements when products are sold. Unfortunately, absorption costing can make it harder to calculate profits.

Variable costing produces results that closely mirror corporate cash flow, notes Accounting for Management. This is a huge advantage for businesses that struggle to manage cash flow. However, financial statements prepared using the variable costing system are typically not accepted by auditors because they do not conform to generally accepted accounting principles.