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Absorption costing and variable costing are two distinct methods for costing products and valuing inventory.
Absorption Costing:
- Definition: Includes all manufacturing costs (fixed and variable) in the cost of goods sold and inventory.
- Impact on Financial Statements: Under absorption costing, fixed manufacturing costs are spread across units produced, affecting the inventory value on the balance sheet and the cost of goods sold on the income statement.
- Impact on Decision-Making: Can lead to profit manipulation based on inventory levels, as fixed costs are deferred in inventory.
Variable Costing:
- Definition: Only variable manufacturing costs are included in the cost of goods sold and inventory. Fixed manufacturing costs are expensed in the period incurred.
- Impact on Financial Statements: Provides a clearer picture of cost behavior and profitability by highlighting the impact of variable costs on profit.
- Impact on Decision-Making: Useful for internal decision-making and cost control, as it emphasizes the impact of variable costs and contribution margin.
Comparison:
- Absorption Costing: Useful for external reporting and compliance with accounting standards, but may obscure cost behavior.
- Variable Costing: Offers better insights for internal management and cost control but is less commonly used for external financial reporting.
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