Variable Costing Vs Absorption Costing

The main difference between variable and absorption costing is the manner in which fixed manufacturing costs are treated. Fixed costs are expenses that continue at the same level no matter how much you manufacture or sell. Absorption costing includes fixed manufacturing overhead as a product cost. Variable costing includes fixed manufacturing overhead as a period cost or expensed in the period in which they are paid or accrued. The absorption costing method is always used for preparing financial accounts. Variable costing is used only for internal use, while absorption can be used for both. The absorption costing method shows less fluctuation in net profits in case of constant production but fluctuating sales.
Under GAAP requirements, absorption

It is common that a report could produce positive net operating income even when the number of units sold is less than the breakeven point. That could lead to faulty pricing decisions. Absorption costing can artificially increase profits by not including all the fixed costs associated with the unsold goods, and can mislead the company when analyzing profitability. If sales in units equals the same as production in units for a period of time, both costing systems will report the same profit. Absorption is affected by changes in production volume When production is greater than sales, absorption costing profits will be greater than variable costing profits. When production is less than sales, absorption costing profits will be lower than variable costing profits. It considers fixed manufacturing overhead as product cost which increase the cost of output. This variance in results can cause the absorption method inaccurate. This could lead to the management decisions not always being precise. This is a reasons companies use both methods to secure

This avoids the costing inaccuracies that can arise from incorrect calculations of production levels and the amount of fixed cost per unit. Variable costing shows profits after all bills have been paid for the period. Some revenues will not be received for those still products still in inventory, but when these products are sold, the company will reflect surplus revenue. Profits not affected by changes in inventories. In many opinions, variable costing is the best system to use for managing cash flow and managers find it more