Question

Which costing system is favorable to shareholders? Why?

Which costing system is required to be presented by GAAP? Why?

Answer 1

There are 2 costing system that can be followed by organisation. The first one is Absorption costing system and second one is Variable costing system. Product cost in Absorption costing system consists of direct material, direct labor, variable manufacturing overheads and fixed manufacturing overheads. But in Variable costing system fixed manufacturing overheads is charged to profit and loss account as period cost. The closing inventory does not include fixed manufacturing overheads. Hence when closing stock is higher than opening stock the results in absorption costing are higher than results in variable costing.

So Absorption costing system is favorable to shareholders since closing stock is valued at higher product cost compared to variable costing. The net income declared under Absorption costing is higher and hence earning per share will be favourable to shareholders.

Absorption costing system is required to be presented by GAAP since it values closing stock at full manufacturing cost and Cost of goods sold includes fixed manufacturing cost in it.