Variable and Fixed Costs



Module 3 - Variable and Fixed Costs

Case Assignment

Differences Absorption and Contribution

Before we difference between the Absorption costing and contribution margin, it is essential to know what these two terms means.

Absorption costing is the costing method in which each cost of manufacturing is absorbed via the unit produced. As far as Contribution margin is concern, it only comprises of variable cost that has been incurred in the production. Direct material, labor and variable overhead will be part of variable costing, while any cost related to fixed items will not be a part of Variable costing rather of Absorption costing (Drury, 2012).

The following are the main difference in these two costing:

Inventory per unit: Income Statement under Absorption costing, inventory cost per unit comprises of direct material, labor and variable manufacturing over-head as well as fixed manufacturing over-head. Considering variable costing, inventory cost per unit consists of direct material, labor and only manufacturing overhead.

Gross Margin: Gross margin under Absorption costing is obtained through subtracting cost of goods sold from the net sales. Gross margin under Variable costing is computed through subtracting variable expenses from net sales in order to get contribution margin and from this contribution margin fixed expenses are subtracted from contribution margin in order turn up at net sales.

Inventories value: Inventories under absorption costing are valued at full costs whereas under variable costing inventories are valued only at variable costs (Jackson, Sawyers, Jenkins, 2012).

Net income under Absorption and Contribution

Net income under these two method are not same due to the fact that one include variable expense only and other include variable as well as fixed cost incurred to produce a product.

Furthermore, net income will be same in two methods only when the production units and sales units are same, otherwise different sales and production units will results in different net income. For instance, when production surpasses sales, profit under absorption costing will be more than variable costing due to the high value of ending stock per unit comparison to the variable costing because fixed manufacturing cost will be included in per unit cost (Drury, 2012).

Another income statement in a different format

The reason for why companies requires for creating another income statement in a different format due to that fact that decision on investments requires wide range of information. Different format information provides different information of the production cost to the managers. Like ...