Case Study 3

School: Southeastern Oklahoma State University - Course: ACCT 5233 - Subject: Accounting

Variable costing is a cost accounting concept that excludes the fixed manufacturing overhead costs from the calculation of production cost of goods. Variable costing is used to conduct break- even analysis that is helpful in ascertaining the number of units that the firm needs to be selling to make a profit. The exclusion of fixed manufacturing overheads can also help in making informed decisions related to the cost-cutting of goods. The variable costing method helps the management in understanding the relationship between profit, cost, and volume. It facilitates this understanding by determining the contribution margin of a product. Variable costing accounting is calculated as the sum of direct labor cost, direct raw material cost, and variable manufacturing overhead divided by the total number of units produced. Variable Costing Income Statement using FIFO: Variable Costing Income Statement using LIFO: Unlike the variable costing approach, absorption costing takes into consideration all costs related to the production including the fixed costs, that helps in determining the per-unit cost. Variable costing pools all the fixed overheads together as one expense and records it in the balance sheet as a single line item, to be charged against net income. On the other hand, absorption costing classifies the fixed overhead costs in two categories; those associated with the cost of goods sold and those associated with inventory. The absorption costing approach is also considered more useful in accounting, especially when all goods are not sold in the same period in which they are produced. Variable costing, on the other hand, can make it tough to determine the right price of goods as it does not consider all costs related to the production process. However, variable costing allows the company to

understand and compare the profitability potential of manufacturing different products as it focuses only on the costs that are directly related to production. It also assists in doing a cost- volume-profit analysis, which helps in determining the number of units required to be sold to earn a profit. Absorption cost formula = (Direct labor cost + Direct material cost + Variable manufacturing overhead cost + Fixed manufacturing overhead) / # of units produced