Select one of these costing methods and explore the various arguments. Determine whether you are “for” or “against” this selected method.
Variable and absorption costing are accounting methods used in determining the costs associated with a product. Variable costing allocates only variable costs such as direct materials, labor and factory overhead, whereas absorption costing accounts for both fixed and variable manufacturing costs (Schneider, 2017). There is debate of the benefits and detriment of each system. For example, variable costing is primarily an internal calculation of contribution margin in which managers are making decisions solely on direct costs; no other expenses are taken into account. Additionally, in variable costing considers fixed production costs as charged expenses (Schneider, 2017). Arguments for the method explain that it is the best method for the short-term and is better at uncovering unethical behavior, as it is more difficult to manipulate than absorption costing.
While variable costing has its advantages and disadvantage, I would preferably be for the technique versus against. According to Schneider (2017), “fixed costs in the income statement under absorption costing are higher than under variable and the result is a lower net profit for absorption costing” (p. 188). Hence, forecasting profit is going to be simpler through the variable process and more difficult through absorption as it is more challenging to predict variations in sales. Additionally, because the variable concept is an internal report it is going to provide a better picture of the health of the company, which best aids in effective planning and decision-making.
Schneider, A. (2017). Managerial Accounting: Decision making for the service and manufacturing sectors (2nd ed.) [Electronic version]. Retrieved from https://content.ashford.edu/
Variable costing is a tool that managers can use to account for expenses of production where all variable costs are added to the product cost during a specific period of production. This is also known as direct costing. As Fremgen (1962) states, “Relevant costs are the only costs that have a bearing on managerial or investment decisions. But what are the relevant costs? Relevant costs are those costs that will be different between two or more future actions, those costs that may be avoided by not undertaking a given alternative” (page 79). This is where I have determined that I am for the variable costing method in managerial accounting — determining which are the relevant costs for now and in the future in paramount as managers. As stated by Schneider (2017), “The fifth consideration is the level at which overhead rates should be set: by task, by machine or labor operation, by activity center, by the department, by the facility, or overall. For a single product operation, overall rates for variable and fixed costs are sufficient. The higher the product and operation diversity, the more likely it is that prices are set for smaller groupings of costs (Sec. 8.6 Standards for Overhead). Diversify is the keyword here and could cut down overall costs.
Fremgen, J. M. (1962). Variable Costing for External Reporting–A Reconsideration. Accounting Review, 37(1), 76. Retrieved from http://search.ebscohost.com.proxy-library.ashford.edu/login.aspx?direct=true&db=bsh&AN=7098035&site=eds-live&scope=site
Schneider, A. (2017). Managerial Accounting: Decision making for the service and manufacturing sectors (2nd ed.) [Electronic version]. Retrieved from