Variable costing is proportionate to the production volume, where it varies with the volume of production. When level of production increases the variable cost also increases and so if level of production decreases then variable cost also decreases.

Variable cost includes;

  • Direct Materials
  • Direct Labor
  • Variable Overhead

Where when direct labor incurs it is charged as expense in the period it incurs and direct material, variable overhead is assigned to inventory.

There are two types of manufacturing costs;

  1. Fixed Cost
  2. Variable Cost

The fixed costs are not directly related to the production and so we cannot reduce these costs but variable costs are related with the production volume by which we tend to say to reduce it in order to reduce the overall cost. The ‘variable costing’ method is used for internal reporting and according to Generally Accepted Accounting Principles it is not included in financial statements for outsiders of the company.

The contribution margin is applied in order to separate the fixed costs and variable costs for the internal financial statement purpose which is then further adjusted before it is issued for outsiders. The ‘absorption costing system’ raises the issue where it increases the income as the level of production increases. We say that when a company aims to increase its profits in order to show more value in the market it could be done by reducing or cutting down the variable costs that create fluctuations such as direct labor, raw material and marketing or advertising. But we should keep it in mind that reducing the cost does not mean to compromise on quality as it would have an negative impact on the company’s image.

We use ‘contribution margin’ to find how much revenue and profits could be earned from each unit of product sold. The ‘break even analysis’ is also calculated to find sales level at which company earns no profit or zero profit.

It overall concludes to be that variable costs include those costs which increases production volume. As costs are related to production levels it provides more accurate information for the decision makers.

financial accounting

December 05, 2019