Reporting Results –Absorption Costing vs. Variable CostingFrom financial accounting you’re already familiar with absorption costing (even if you aren’t aware of it). And, the job costing systems that we have been discussing were absorption costing systemsUnder Absorption costing, both variable and fixed manufacturing costs are accounted for as product costs, i.e., they are allocated to the product and included in (debited to) WIP. Thus, under absorption costing allmanufacturing costs are capitalizedas inventory costs and, subsequently, are recognized as expenses only when the goods aresold.But, another costing scheme – variable costing – can and is often used for managerial decision making and reporting purposes.Under Variable costing, only the variable manufacturing costs areaccounted for as product costs and capitalizedas inventory costs. Fixed manufacturing costs (fixed overhead) are treated as period costs and are expensed each period as they are incurred.
The fact that firms must use absorption costing for financial reporting can have unexpected (and often undesirable) consequences for the financial reports that they distribute to the public. To illustrate those consequences and to compare the effects of an absorption costing system with those of a variable costing system, we will examine the example on the following page.
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