Question

Explain the difference between absorption costing and variable costing and which you think is more useful.

Answer 1

								Basis	Variable Costing	Absorption Costing
								Costs	Variable costing includes only variable costs directly incurred in the production	Absorption costing includes both variable costs and fixed costs related to production.
								Internal / External Use	Variable costing is generally used for internal reporting purposes. Managerial decisions are taken on the basis of variable costing	Absorption costing is used for reporting to the external stakeholders as well as for the purpose of filing taxes. It is in line with GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards).
								Relevance	Variable costing is used for comparing the profitability of different product lines. The organization can carry out an analysis based on costs, volumes, and profits.	Absorption costing is used for calculating per unit cost based on all costs including fixed overhead costs.
								Reporting	Variable costing is based on internal specifications of reporting and presentation.	Absorption costing is based on external reporting standards given by external agencies.
								Inventory	Variable costing involves only variable production costs to be assigned to inventory, work-in-progress, and cost of goods sold.	Absorption costing involves considering all production costs and including them in inventory and work-in-progress.
								Contribution	Variable costing calculates contribution which is the difference between sales and variable cost of sales.	Absorption costing is used to calculate the net profit.
								Profit	Profit is much easier to predict as it is a function of sales.	It is much more difficult to predict the effect of change in sales on profit.
									marginal costing is not allowed for financial reporting purposes whereas absorption costing can be used for both financial and management accounting. So absorption costing is best.