Variable Costing. To allow for deficiencies in absorption costing data, strategic finance professionals will often generate supplemental data based on variable costing techniques. As its name suggests, only variable production costs are assigned to inventory and cost of goods sold.
Advantage: Unaffected by Inventory Changes Companies that use variable costing experience fewer cost changes from inventory adjustments. For example, changes in product cost, selling price or the company’s sales mix will not affect the profit for a single accounting period.
Companies can expect smoother profit reporting throughout multiple accounting periods, making forecasting costs from production increases easier. Advantage: Profitability Estimating Estimating future profits is often easier with variable costing when compared to absorption costing. Fewer changes to inventory costs will result in a better historical record of actual production costs. Companies can also break down each department or product line under variable costing, which provides a more thorough analysis of a company’s business operations. Adding new products or expanding current production levels also relies on this consistent information. Brought to you by Disadvantage: Non-Conforming Method A significant disadvantage with variable costing is that it does not conform to generally accepted accounting principles. While companies can use this reporting method, auditors may challenge the use of variable costing.
Generally Accepted Accounting Principles (GAAP) has no preference as to how variable fixed costs are handled in a company’s production process. Variable costing expenses fixed costs rather than adding them to products, creating a distortion for actual production costs. Disadvantage: Lower Net Income Another issue with variable costing is the reduction of reported net income. Expensing fixed production costs as a period expense lowers net income for each accounting period. Companies will face lower tax liabilities from government agencies, saving the business money. Government agencies, however, can see this as inappropriate financial reporting and challenge the company’s financial accounting method.
The total expenses incurred by any business consist of and variable costs. Fixed costs are expenses that remain the same regardless of production output. Whether a firm makes sales or not, it must pay its fixed costs, as these costs are independent of output. Examples of fixed costs are rent, employee salaries, insurance, and office supplies. A company must still pay its rent for the space it occupies to run its business operations irrespective of the volume of product manufactured and sold. Although, fixed costs can change over a period of time, the change will not be related to production. Variable costs, on the other hand, are dependent on production output.
Variable Costing On Flowvellane
The variable cost of production is a constant amount per unit produced. As volume of production and output increases, variable costs will also increase. Conversely, when fewer products are produced, the variable costs associated with production will consequently decrease. Examples of variable costs are sales commissions, direct labor costs, cost of raw materials used in production, and utility costs.
The formula for variable cost is given as. A company can increase its profits by decreasing its total costs. Since fixed costs are more challenging to bring down (for example, reducing rent may entail the company moving to a cheaper location), most businesses seek to reduce their variable costs. Therefore, decreasing costs usually means decreasing variable costs. If the bakery sells each cake for $35.00, its per cake will be $35 - $15 = $20. To calculate the net profit, the fixed costs have to be subtracted from the gross profit. Assuming the bakery incurs monthly fixed costs of $900 which includes utilities, rents, and insurance, and its monthly profit will be.