What is variable costing
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What is variable costing?
Variable costing is a method of accounting that assigns only variable costs to inventory and cost of goods sold. Fixed costs are expensed in the period in which they are incurred. This means that variable costing income statements will show a higher contribution margin than absorption costing income statements, which assign both variable and fixed costs to inventory.
Why use variable costing?
Variable costing is a useful tool for managers who need to make decisions about pricing, product mix, and production levels. By knowing the contribution margin per unit, managers can see how much profit each unit sold will generate. This information can be used to set prices that will maximize profits, or to determine which products to produce more of and which products to produce less of.
How does variable costing work?
Variable costing begins by identifying all of the costs incurred by a business. These costs are then classified as either variable or fixed. Variable costs are those that change in proportion to the volume of production. Fixed costs, on the other hand, do not change with the volume of production.
Once the costs have been classified, variable costing assigns only the variable costs to inventory and cost of goods sold. Fixed costs are expensed in the period in which they are incurred. This means that the variable costing income statement will show a higher contribution margin than the absorption costing income statement.
Example of variable costing
Let’s say a company produces widgets. The variable costs per widget are $10. The fixed costs for the company are $100,000. If the company produces and sells 10,000 widgets, the variable costing income statement will look like this:
Sales (10,000 widgets * $10/widget) $100,000
Variable costs (10,000 widgets * $10/widget) $100,000
Contribution margin $0
Fixed costs $100,000
Net income $(100,000)
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As you can see, the contribution margin is $0. This is because the variable costs and fixed costs are equal. In other words, the company is breaking even.
Advantages of variable costing
There are several advantages to using variable costing. First, it is a simple and easy-to-understand method of accounting. Second, it provides managers with valuable information about the contribution margin per unit. This information can be used to make decisions about pricing, product mix, and production levels. Third, variable costing is consistent with the concept of marginal costing. Marginal costing is a method of determining the cost of producing one additional unit of output.
Disadvantages of variable costing
There are also a few disadvantages to using variable costing. First, it does not provide a complete picture of the costs incurred by a business. Fixed costs are still incurred, even if no units are produced. Second, variable costing can be misleading when comparing the profitability of different products. This is because the variable costing income statement does not take into account the fixed costs that are incurred to produce each product.
Variable costing is a useful tool for managers who need to make decisions about pricing, product mix, and production levels. However, it is important to be aware of the limitations of variable costing before using it to make decisions.
I hope this explanation of variable costing was helpful. Please let me know if you have any other questions.
What is variable costing
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