The fixed costs of depreciation, taxes, insurance, supervisory, salaries, and so on, are just as essential to manufacturing products as are the variable costs. The company evaluates each business opportunity using absorption costing as its base cost. The variable costing income statement highlights the relationship between sales and income whereas the absorption costing income statement does not generally show any association between sales and income. As an illustration, the wage of a worker in a care section will be allocated to the full to the care section. It might be pointed out that the advantages or disadvantages do not actually relate to internal use or external use, but rather to the method itself. Distortion occurs because different bases of apportionment produce different allocation to products and affect different results.
Solution: Advantages of Absorption Costing: Following are the main advantages of absorption costing: 1. Having a more complete picture of cost per unit for a can be helpful to company management in evaluating profitability and determining prices for products. After the fall of communism, accounting methods were changed in Russia to bring them into closer agreement with accounting methods used in the west. It is highly useful for price fixation of a product. The fixed manufacturing costs are reported as separate item in the variable costing income statement, they are easier to identify and control by a higher level of management than when they are spread among units of product as in absorption costing. Brought to you by Discourages Profitable Business A disadvantage of absorption costing involves pricing decisions.
However, there is little doubt among accountants that direct costing is better suited for internal management purposes in planning, control, and decision making. Hence, the preparation of periodic operating statements becomes unrealistic. Using the absorption method of costing, the unit Product Costs Product costs are costs that are incurred to create a product that is intended for sale to customers. Help the Trade Union Bonus calculation is very easy to the trade union. Activities include those required to gain new customers and to maintain relationships with current customers as well as ordering, packaging, handling, customer service, etc. The understanding of contribution margin and sales pricing is one of the first things they must learn if they are to be successful.
Under variable costing, the other option for costing, only variable costs are considered for production. As long as managers are evaluated based on short term income and have the potential to leave the organisation, absorption costing creates an incentive to overproduce. Cost Accounting fails to solve the problems relating to work study, time and motion study and operation research. However, the necessary data required special studies because the information was not readily available in the accounts as it is in direct costing. Lesser figure of contracts will ensue in higher competition and companies with relevant and proper bing systems will hold competitory advantage to win more orders in a low net income border environment. But when the level of output changes the cost per unit also changes because of the presence of fixed cost which remains constant.
The unit sales are projected to be 20,000 per year. For a specific level of management, controllable costs are costs that it controls directly and non controllable costs are costs that another level of management controls. The manager, therefore, needs to use his intuition for decision making. This situation arises because the fixed overheads that are being absorbed into the cost of products are estimated, as original overheads are realized when actual fixed costs are incurred. Supporters of absorption costing argue that fixed production costs are just as much used in the production of goods and services as the variable production costs. Most managerial decisions are cost-related, and an understanding of these relationships is essential. Therefore, variable costing advocates argue that fixed manufacturing costs are not part of the costs of producing a particular unit of product and thus the matching principle dictates that fixed manufacturing costs should be charged to the current period.
In the long run, all the costs are variable. Management has to consider other factors also before deciding to drop a product line such as customer goodwill. The marginal costing technique is very simple to understand and easy to operate. Adoption of absorption costing makes calculations easier for small businesses as it is unlikely that these entities have a lot of products. Product Pricing Marketing department managers have been using variable costing in setting selling prices for many years. Each stage of the life-cycle has separate fixed cost and short-run marginal cost. Absorption costing is, therefore, different from the other costing methods as it takes into account fixed manufacturing overhead counting expenses like factory rent, utilities, amortization.
Under marginal costing, the fixed costs remain constant and variable costs are varying according to level of output. In case actual performance is different from the budgeted activity level, corrective action can be taken by management. This information is supplied by the costing records and helps to prepare financial accounts without any further delay. Primarily this lack of acceptance is because direct costing is not a generally accepted accounting procedure. If so, correct and reliable data was available from the costing records which are highly useful to the government, share holders, the creditors and the like. Period to period cost comparison also helps cost control. Because you assign a per-unit amount for fixed expenses, each product in inventory has a value that includes part of the fixed overhead.
The direct cost income statement will enable management to see and understand the effect that period costs have on profits and will facilitate better decision making. Identify the cost aims and activities. But, in fact, there can be no justification for such actions. Disadvantages of Variable Costing Variable costing shows full payment for fixed-overhead expenses for the accounting period. It cannot be true under all circumstances. Although operating income may increase now, future operating income will probably decrease because of increased repairs and less efficient equipment.
The variable cost of sales changes in direct proportion with volume. It is required in preparing reports for financial statements and stock valuation purposes. Knowledge of the contribution margin provides guidelines for the most profitable pricing policies. At the other extremes, variable costing results may mislead management during a business recession during which variable costing profit will be minimized due to sales being extremely lower than production. Allotment, allotment and soaking up rates Allotment of an disbursal takes topographic point when it can be specifically charged to a cost Centre.
This not only makes the costing task simpler, easier and systematic for such businesses but also takes into account the effects of fluctuating turnover as the costs attached to the products are already absorbed into the products. This is because, though the included in do not contribute directly to the creation of the , there is still some residual effect on the production which drives up the to produce. Once he learns that he cannot control part of the costs with which he is charged, his sense of responsibility for controlling his direct cost somehow seems to weaken. Elimination of Wastes, Losses and Inefficiencies A good cost accounting system eliminates wastes, losses and inefficiencies by fixing standard for everything. Some accountants are not fully conversant with the marginal techniques themselves.