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Definition of Variable CostingVariable costing refers to all direct cost and variable overhead incurred in the production/manufacturing of a product or rendering of service and excludes all fixed costs. Variable costing focus on all those costs which are directly impacted and affected by a change in production, unlike fixed cost which is static and stationary. Variable costing is frequently used by management to undertaken break-even analysis and determine contribution margin as well. Variable costing is also known as Marginal Costing, Direct Costing, Differential Costing as well as Out of Pocket Costing as well. ExplanationA product or service manufactured/delivered by the business has some costs associated with it. These costs are Fixed Costs (which doesn’t change too often) and Variable cost (which are directly affected by the volume of production). Variable costing can be explained simplistically as the study of variable cost components used in the manufacturing of product or service by the business. Variable costing varies with units of production and as such is an ideal costing measure for taking decisions related to the scaling of business, acceptance of new orders, prioritizing products in a portfolio of products by the business. Features of Variable Costing
Example of Variable CostingLet’s understand Variable costing with the help of an example along with its utility. ABC International has presented the following manufacturing cost incurred in the production of 100000 mobile phones during January 2020:
(Excel sheet attached) Recently ABC International was approached for special order for manufacturing of 50000 mobile phones for one of its corporate clients. The client offered $ 14 per unit which was rejected by the Costing Head. However, the new CEO insisted that the company should compute its Variable Costing of the product as fixed costs are already incurred and there is already excess capacity available to manufacture the required 50000 units of mobile phones. Since Variable Costing is focused only on Variable cost factors the per unit variable costing is computed as follows: For 50000 units all variable costs like Direct Material and Direct Labor will be 50% as the above cost is for 100000 units of mobile phones.
Since Variable Cost is less than the $14 offered to ABC International, it should accept the special order as this will result in a contribution of $0.20 per mobile phone. Importance of Variable CostingVariable costing is an indispensable part of Management decision making exercise. These costs are more relevant and require management direct involvement as fixed cost is already incurred and irreversible. It enables making comparisons among profitability of different units within the business more meaningful as it is focused on Variable cost factors and helps in overcoming problems related to the allocation of fixed costs which at times are difficult to bifurcate. Advantages of Variable CostingSome of the advantages are given below:
Disadvantages of Variable CostingSome of the disadvantages are given below:
Comparison between Variable Costing and Absorption Costing
ConclusionVariable Costing is an important part of product costing and forms part of the internal reporting framework for business. Variable Costing is a useful measure of identifying cost associated with the product in cases where allocating fixed cost is not viable or possible or the management is more interested in knowing the additional cost to be incurred in production without considering fixed cost at all. Recommended ArticlesThis is a guide to Variable Costing. Here we also discuss the definition and example of variable costing along with advantages and disadvantages. You may also have a look at the following articles to learn more –
What is the advantage of using variable costing over full absorption?Variable costing is more useful than absorption costing if a company wishes to compare different product lines' potential profitability. It is easier to discern the differences in profits from producing one item over another by looking solely at the variable costs directly related to production.
Which of the following is the advantages of variables costing?The advantages of the variable costing
Variable costing provides management with data on variable costs and contribution margins needed to make daily decisions on special orders, capacity expansion, and production shutdown.
Which one is better variable costing or absorption costing?Variable costing results in gross profit that will be slightly higher. In turn, that results in a slightly higher gross profit margin compared to absorption costing.
What are some of the benefits to a manager from using variable costing instead of absorption costing for internal decision making?Conversely, absorption costing meets the requirements of U.S. GAAP, but is not as useful for internal decision-making purposes. Another advantage of using variable costing internally is that it prevents managers from increasing production solely for the purpose of inflating profit.
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