Absorption costing and variable costing methods: Inclusion or Exclusion of Fixed Overhead Items to Products-> Ordinarily, cost accounting procedures apply all factory costs to the output of a period. These procedures are called Absorption Costing or Conventional Costing or Full Costing where both fixed and variable expenses are included in overhead rates.
Another method of costing which is termed Direct Costing or variable costing or marginal costing – is sometimes used, chiefly for internal management purposes. Under this method of costing, only variable overhead is included in overhead rates calculation. Absorption Costing And Variable Costing are two distinct methods.
Fixed expenses do not become product costs but are treated as period costs meaning that they are charged off in total each period as are marketing and administrative expenses. They are not included in process or finished goods inventories.
Absorption costing and variable costing methods are the result of two entirely different cost concepts with respect to product cost, period cost, gross income and net income. The two methods result in different inventory costs and different period profits. Direct Costing or variable costing will be discussed in detail in next few notes.
Each of the various bases discussed for applying overhead may be used with Direct Costing or Variable costing, with the rates based on normal or expected actual capacity. Of the five main factors influencing the selection of overhead rates. Two have not been discussed; namely, in this article:
- the use of a single rate or several rates and
- the use of separate rates for service activities.
These methods will be discussed in detail in next few notes.