Question

Yes, absorption costing includes all costs associated with production, and knowing the "all in" cost certainly important.

However, suppose management decides to track production cost per unit to use as a basis for evaluating the production line manager. In January, production cost per unit was $15, but in February it jumped to $5,010 under absorption costing. Should the production line manager be fired because of this cost per unit?

But looking at it from the variable costing perspective, there was no change in cost per unit throughout the three months! Since the production line manager has no control over the fixed costs, it would be unfair to use absorption costing for this purpose.

Can you think of other types of situations/decisions that use variable costing?

Answer 1

Variable costing product costs consists of only direct material, direct labor and variable manufacturing overhead. It does not consist of fixed manufacturing overhead because it is charged to the period in which it is incurred. Variable costing is used for internal decision making. Some of them are listed below

· Evaluation of various alternative courses of action. For example : increase in spend of advertising, Increase in sales commission, automation projects, etc

· Profit planning by preparing statement at different level of activities

· Cost management by constructing flexible budgets at different levels of activities

· New product launches and pricing decisions. It helps in understanding relationship between cost, volume and profit.

· In regular decision making like make vs. buy, product mix decision, shut down vs. continue, sell or process further, etc