CASE 3- Variable and Fixed Costs Essay Example | Topics and Well Written Essays - 750 words

CASE 3- Variable and Fixed Costs - Essay Example ch refers to the costing methodology in which all the manufacturing and direct costs were allocated to the products and used in the calculation of the costs of inventory (opening, in process or closing). All the non manufacturing costs are directly charged to the income statement and were excluded from the cost of inventory (opening, in process or closing). This method is also known as full costing method or system. (Drury, 2004) An alternative to this method is a variable costing method. Under variable costing approach the cost of a product includes variable costs (costs that vary with the level of production) of production only. All the fixed costs (costs that are not dependent on the level of production) are directly taken to the profit and loss statement and not form the part of inventory cost (opening, in process or closing). It is also called as direct costing system. (Matz & Usry, 1980) 1. If production in a period equals the sales in that period, then profits calculated under both the methods are same. The reason is that the amount of fixed overheads that will be charged to the profit and loss statement under absorption costing will be the fixed expenses incurred during the period, which is also charged in the profit and loss statement under variable costing method. Therefore, net income under both methods will be same. The fixed costs pertaining to opening inventories, under absorption costing method, will be carried forward to the next period, As opening and closing inventories are same (since sales equals production). (Drury, 2004) 2. If the production during the period exceeds the sales during that period, then absorption costing system results in higher profits as compared to the variable costing systems, since fixed cost pertaining to the units sold is less than the total fixed costs for the period (As production is greater than sales and fixed costs in absorption costing are allocated on the basis of units produced). As under the absorption