Question

You have just taken a job at a manufacturing company and have discovered that they use absorption costing to analyze product costs and subsequent cost-volume-profit decisions. You would like to introduce them to variable costing and explain to them why this costing method can be used and why it is helpful.

Answer 1

Variable costing is a method of costing which can make it easy for a manufacturing concern to use the same over other costing methods like absorption costing. Following are the benefits and advantages of using variable costing method over absorption costing:

• It provides a better understanding of the effect that fixed cost is going to have on net profitability of the company.
• Variable costing provides clear picture of the exact incremental cost which is being associated with a product and a company can compare which product to manufacture by looking at the profitability of the same for the organization.
• Fixed cost is an element in costing which occurs irrespective of the volume of manufacturing and hence variable costing only ascertain the extra cost other than fixed cost which would incur to produce a particular product and therefore this feature of variable costing makes it easy for the management in the longer run.
• It is much easier to adopt variable costing method then absorption costing and the efforts requires is also comparatively less.
• .The net operating income on which the company arrives after using variable costing method is more close to the cash flows of the company, and hence it is recommended for companies and businesses which are suffering from problems of cash flows.

Therefore, all these benefits makes it useful for company especially a manufacturing concern to use variable costing instead of absorption costing method for the purpose of decision making and cost analysis.