Variable costing is a method of manufacturing cost accounting used to place a value on the final product. Unlike absorption costing, which considers all manufacturing costs for inventory value, the variable costing method does not consider fixed costs associated with producing the final product. Different methods of inventory valuations will have varying affects on net income.
What’s Figured Into the Variable Costing Method?
Only materials, labor and variable manufacturing overhead costs and expenses associated with a finished manufactured product are figured into the determining the unit cost. The following is a list of categories that are used to determine the cost of a single unit of a finished product using the variable costing method.
- Direct Materials Cost is the actual cost of all materials that are used in the production of a finished product.
- Direct Labor Cost is the expense of the actual internal wages associated with the production of a finished product.
- Variable Manufacturing Overhead Cost fluctuates with output. Examples may include equipment depreciation, utilities, outside labor, plant or equipment maintenance and material handling.
Fixed manufacturing costs like salaries, rent and insurance are not figured into the inventory value. Also fixed and variable selling costs are generally not figured into the inventory value when using the variable costing method. Instead these types of costs are expensed and reduced from income as they actually occur.
Determining the Cost of Goods Sold Using Variable Costing
Once the above categories costs are figured, the next step is to get a total sum of all the variable cost categories. The total units produced are then divided into the total sum of the variable cost categories. As an a example:
- Direct materials cost $1,000,000
- Direct labor cost per $500,000
- Variable manufacturing cost $250,000
- Total all costs $1,750,000
- Units produced 500,000
Total variable cost per unit $3.50 (500,000/$1,750,000)
Variable Costing Method’s Affect on Income
When using the variable costing method to value inventory, the cost of sale is reduced compared to using absorption costing, where all costs are used. Since the cost of sale is less, a greater gross profit is realized when the products are sold. Excess production inventory (unsold) will cause income to be less because fixed expenses aren’t allocated to the product.
Variable costing may not be acceptable for external reporting of the income statement for income tax purposes. A CPA or tax professional should be consulted before implementing the variable costing method. Inventory costing methods will also have an affect on asset valuation as reported on the balance sheet.
James Clausen - Clausen received a Bachelors Degree in Business Administration in Automotive Management and Marketing at Northwood University, graduating ...
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