Definition of Variable Costing
Variable costing is a managerial accounting method where only variable production costs—those costs that change directly with changes in the level of production—are included in the cost of a product. Overhead costs are treated as period costs and are not allocated to individual units of production. This approach contrasts with absorption costing, where both fixed and variable costs are included in the cost of a product.
In variable costing, expenses that vary directly with production, such as raw materials and direct labor, are included in product costs. Fixed overhead costs, such as rent and salaries, are treated as expenses of the period in which they are incurred.
Examples of Variable Costing
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Manufacturing Industry: In a factory that produces widgets, variable costs would include the direct materials like metal and plastic, and the direct labor costs of workers assembling the widgets. Fixed costs such as the salary of the factory manager and the lease of the factory building are not included in the cost per widget but are treated as period costs.
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Service Industry: For a consulting firm, variable costs might include consultant wages if they are paid per project. Overhead costs such as the office lease and administration salaries would be treated as period costs under variable costing.
Frequently Asked Questions (FAQs)
What is the primary advantage of using variable costing?
The primary advantage is more accurate product cost information for decision-making, particularly for short-term decisions like pricing and product mix. It helps in understanding the impact of fixed versus variable costs on profitability.
How does variable costing differ from absorption costing?
Variable costing includes only variable production costs in product cost, while absorption costing includes both variable and fixed production costs.
Can variable costing be used for external financial reporting?
No, variable costing is not acceptable for external financial reporting under generally accepted accounting principles (GAAP) or International Financial Reporting Standards (IFRS). It is used internally for management decision-making.
What types of businesses benefit most from variable costing?
Businesses with high fixed costs and products with widely varying levels of production, or those needing detailed cost management for decision-making, benefit most.
Is the term “marginal costing” the same as “variable costing”?
Yes, marginal costing and variable costing refer to the same accounting method.
Related Terms
Absorption Costing
Absorption costing, also known as full costing, is an accounting method where both fixed and variable production costs are included in the cost of goods sold.
Direct Costing
Direct costing is another term often used interchangeably with variable costing, emphasizing the inclusion of direct costs in product cost calculation.
Fixed Costs
These are costs that do not vary with production levels, such as salaries, rent, and utilities.
Contribution Margin
The contribution margin is the sales price of a product minus its variable costs. It is used to cover fixed costs and provide a profit.
Online Resources
- Investopedia on Variable Costing
- Accounting Coach on Variable Costing
- Corporate Finance Institute on Variable Costing
Suggested Books for Further Studies
- “Cost Accounting: A Managerial Emphasis” by Charles T. Horngren, Srikant M. Datar, and Madhav V. Rajan
- “Management and Cost Accounting” by Alnoor Bhimani, Charles T. Horngren, Srikant M. Datar, and Madhav V. Rajan
- “Cost and Management Accounting: An Introduction” by Alan Pizzey
Accounting Basics: “Variable Costing” Fundamentals Quiz
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