Variable costing is an accounting method used to calculate the cost of producing a product or service. Unlike absorption costing, which allocates all costs associated with production to the product, variable costing only allocates direct costs to the product.
The Basics of Variable Costing
Variable costing, also known as direct costing, is a method of cost accounting that only includes direct costs in the calculation of the cost of producing a product or service. Direct costs include materials and labor, while indirect costs such as rent, utilities, and equipment depreciation are treated as period costs and are not allocated to the product.
Under variable costing, the cost of a product or service is calculated by adding together all the direct costs involved in its production. This method of costing is used by businesses to determine the variable cost of producing a product or service.
Advantages of Variable Costing
One of the main advantages of variable costing is that it provides a more accurate picture of the cost of producing a product or service. By only including direct costs in the calculation, it provides a more precise understanding of the cost of producing a product, which can be useful in setting prices and making decisions about product lines.
Another advantage of variable costing is that it is easier and faster to calculate than absorption costing. Businesses that use variable costing only need to track direct costs, which can be simpler and less time-consuming than tracking all costs associated with production.
Disadvantages of Variable Costing
One of the main disadvantages of variable costing is that it can provide an incomplete picture of the total cost of producing a product or service. Because it only includes direct costs in the calculation, it does not take into account all the costs associated with production, which can result in an incomplete understanding of the true cost of a product or service.
Another disadvantage of variable costing is that it is not accepted by generally accepted accounting principles (GAAP) for external financial reporting. This means that businesses that use variable costing may need to maintain two sets of accounting records – one for internal management purposes and one for external financial reporting.
Conclusion
Variable costing is an accounting method used to calculate the cost of producing a product or service that only includes direct costs in the calculation. It provides a more precise understanding of the variable cost of producing a product or service and can be easier and faster to calculate than absorption costing. However, it can also provide an incomplete picture of the total cost of production and is not accepted by GAAP for external financial reporting. As with any accounting method, businesses should weigh the advantages and disadvantages of variable costing to determine if it is the right method for their needs.