Question

• What is the difference between variable and absorption cost per unit?
• Why might a company use absorption costing instead of variable costing? Why might it use variable costing instead of absorption costing?
• Which produces the correct product cost, absorption or variable costing?

Answer 1

Solution. Variable cost per unit is calculated with variable costing method, which only includes variable cost of production of goods produced. Whereas, absorption cost per unit is calculated with absorption costing method, which includes total cost(variable+fixed) of production of goods produced.

When an organization in order to calculate external reports for filing taxes and others need to arrive to the cost of its products and inventory valuation, employs absorption costing instead of variable costing. When an organization enters in a competitive business economic market, in order to sustain, it needs to analyze its different product lines cost, and profit margin from the same, as fixed costs remain constant, in such scenario we compute and analyze by variable costing method instead of absorption costing.  

Absorption costing helps in arriving to correct product cost as it includes both variable and fixed costs to compute cost of goods. Which leads in arriving better track of organization's profitability picture and facilitates in decision making and publishing external reports on taxes and others.