Still no test grades. Chapter 7, today.Chapter 7: Variable Costing
Under variable costing, only those manufacturing costs that vary with output are treated as product costs. Under absorption costing, all manufacturing costs are treated as product costs.
Because product costs are recognized when the products are sold, the costing method used will affect the net income of the organization.
Where inventory is increasing, absorption costing will show a higher net operating income than variable costing. Where inventory is decreasing, the reverse will be true. Absorption costing and variable costing will show the same net operating income where production and sales are equal, and therefore inventory does not change.
Note that in the long run, the two methods will both give the same, correct, results. Only in the short run will the numbers be different.
Absorption costing does not support CVP analysis (see chapter 6), and is generaly not preferred for decision-making purposes. Absorption costing allows costs to move outside the period in which they are incurred, and thus can allow confusion.