Variable costing, also known as marginal costing, is an accounting method in which only variable costs are included in product costs. Fixed manufacturing overhead is treated as a period cost and is expensed in the period incurred.
Historical Context
The concept of variable costing has been utilized for several decades, particularly gaining prominence in the mid-20th century with the rise of managerial accounting. The method was developed to provide clearer insight into how production volume affects profitability, aiding managers in decision-making.
Key Concepts
Types/Categories
- Direct Costs: Costs that can be directly attributed to the production of a specific good.
- Indirect Costs: Costs that are not directly linked to production.
- Variable Costs: Costs that vary with the level of production output.
- Fixed Costs: Costs that remain constant regardless of production levels.
Key Events
- Introduction: Early 1900s with increased industrial production.
- Formalization: Post-WWII era as companies sought efficient cost-control measures.
- Regulation: Increasing adoption in the mid-20th century with guidelines by accounting bodies.
Detailed Explanation
Variable costing involves the following key steps:
- Identification of Variable Costs: Costs that change with the level of output such as raw materials and direct labor.
- Allocation to Products: Assigning variable costs directly to units produced.
- Exclusion of Fixed Overhead: Treating fixed manufacturing overhead as period expenses, not product costs.
Mathematical Model
Charts and Diagrams
pie title Cost Distribution
"Variable Costs": 70
"Fixed Costs": 30
Importance and Applicability
Importance
- Managerial Decision-Making: Provides clear insights into the impact of production volume on costs and profits.
- Cost Control: Helps in identifying variable costs that can be controlled or reduced.
- Pricing Strategies: Assists in setting competitive prices by understanding marginal costs.
Applicability
- Manufacturing Industries: Where variable costs make up a significant portion of total costs.
- Service Industries: To understand cost behavior with changes in service volume.
Examples
- Manufacturing: A factory producing widgets would use variable costing to allocate raw material and direct labor costs to each unit produced.
- Retail: A retail store could apply variable costing to inventory management by tracking the cost of goods sold based on variable expenses like supplier costs.
Considerations
- Regulatory Compliance: Must ensure compatibility with accounting standards.
- Business Model: More effective for companies with high variable cost structures.
Related Terms with Definitions
- Absorption Costing: A costing method where both variable and fixed manufacturing costs are allocated to products.
- Contribution Margin: The selling price per unit minus the variable cost per unit.
Comparisons
- Variable vs. Absorption Costing:
- Variable Costing: Only variable costs are product costs.
- Absorption Costing: Both variable and fixed costs are product costs.
Interesting Facts
- The term “marginal costing” reflects the focus on the “margin” or incremental cost of producing an additional unit.
- The approach is particularly useful in break-even analysis.
Inspirational Stories
Jack Welch, former CEO of General Electric, utilized variable costing to streamline operations and boost profitability during his tenure, illustrating its practical impact on business management.
Famous Quotes
“Costs do not exist to be calculated. Costs exist to be reduced.” - Taiichi Ohno
Proverbs and Clichés
- Proverb: “A penny saved is a penny earned.”
- Cliché: “Cutting costs.”
Expressions, Jargon, and Slang
- Break-even Point: The level of sales at which total costs equal total revenue.
- Variable Overhead: Costs that vary with production but are not directly tied to a specific unit.
FAQs
What is variable costing?
Why is variable costing important?
How does variable costing differ from absorption costing?
References
- Drury, C. (2013). Management and Cost Accounting. Cengage Learning.
- Horngren, C. T., Datar, S. M., & Rajan, M. V. (2015). Cost Accounting: A Managerial Emphasis. Pearson Education.
Final Summary
Variable costing, or marginal costing, is a fundamental method in managerial accounting, enabling businesses to understand the dynamics between production volume and costs. By focusing on variable costs, it aids in decision-making, cost control, and pricing strategies, making it a vital tool for both manufacturing and service industries. Understanding its concepts, application, and comparisons with other costing methods is essential for effective financial management.
