Accounting and finance are complex spheres in which few people can actually feel confident. The main problem is that substantial mathematic skills are needed to make sense of accounting, not to say about the knowledge of numerous terms. Variable costing income statement is one of them. According to the definition provided by Needles, Powers, and Crosson (2010), variable costing refers to the method of writing a company’s performance reports that define managers’ controllable costs as either fixed or variable. This variable costing is not presented in the form of the traditional income statement. Instead, a variable costing income statement is needed. In this essay, the author attempts to explain what this term means and how it differs from traditional statements, which are also referred to as absorption costing.
Types of Costs
To begin with, one needs to determine the types of costs. Direct costs are costs that can be directly identified with a product or service. Variable costs, in turn, are calculated by their behavior in relation to changing activity levels (Lucey, 2002). In other words, they are dependent on the emergence of specific cost-controlling variables (Ehrlenspiel, Kiewert, & Lindemann, 2007). Variable costs examples include sales commissions, raw materials, packing costs, production wages, and many other variables. There is also a fixed cost. This term refers to a cost that tends to be unaffected by activity fluctuations (Lucey, 2002). Overhead costs, in turn, are calculated by combining both fixed and variable costs (Ehrlenspiel et al., 2007). Therefore, different costs should be calculated differently and presented in the form of statements.
Absorption vs Variable Costing Income Statement
Before comparing two types of statements, one needs to explain how a variable costing income statement looks like. Warren, Reeve, and Duchac (2017) explained that in this type of report, the cost of goods (services) manufactured or provided by a company (factory) is composed only of variable costs. Thus, the cost comprises only labor, materials used, etc. Moreover, in income statement variable costing calculations, fixed overhead costs are not considered when the cost of goods produced is calculated. Instead, they are treated like a period expense (Warren et al., 2017). A variable costing income statement example applied to different business spheres is available online and cannot be included in this paper due to word count limitations.
Now let us explain how variable costing income statement vs absorption differ. Needles et al. (2010) highlighted that in the traditional (absorption) statement, manufacturing costs depend on the cost of goods sold. Therefore, the phrase “absorption costing income statement cost of goods sold” that is often used in google search to look for recommendations on how to prepare a variable costing income statement is incorrect. Variable costing statement is different. It considers the variable costs exclusively. Notably, traditional reports can be misleading. Variable costing income calculations, however, are favored by managers, as they allow considering product pricing, cost control, and production planning (Warren et al., 2017).
To summarize, analyzed income statements are part of the standard process of income calculations. The difference between the types of statements may not be clear to people having limited knowledge in accounting and finance. However, these differences should be necessarily considered. The absorption costing application and variable costing use are different, but they both are generally employed for making more accurate calculations. Given the complexity of the issue, it is recommended for the companies to seek professional services when assessing income to avoid misinterpreting and errors.
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Ehrlenspiel, K., Kiewert, A., & Lindemann, U. (2007). Cost-efficient design. New York, NY: Springer Science & Business Media.
Lucey, T. (2002). Costing. London: Cengage Learning EMEA.
Needles, B. E., Powers, M., & Crosson, S. V. (2010). Financial and managerial accounting. New York, NY: Cengage Learning.
Warren, C. S., Reeve, J. M., & Duchac, J. (2017). Accounting. New York, NY: Cengage Learning.