Rashid Javed

Variable Costing System

Under variabkle costing system, only those costs are treated as product costs that vary with output. All fixed manufacturing costs are treated as period costs.

Variable costing is very important element of cost and management accounting. Variable costing charges products with only those manufacturing costs that vary directly with volume.

Only prime costs (direct materials and direct labor) plus variable factory overhead expenses are assigned to inventories, both work in process and finished goods, and to the cost of goods sold. Thus, these variable costs are charged to the product while fixed manufacturing costs are totally expensed in the current period.

Manufacturing costs such as depreciation, insurance, and taxes that are a function of time rather than of production are excluded from the cost of the product. Also excluded are salaries factory supervisors and office employees as well as wages of certain factory employees, such as maintenance crews and guards, which are considered period costs rather than product costs.

Direct costing focuses attention on the product and its costs. This interest moves in two directories: (1) to internal uses of the fixed variable cost relationship and the contribution margin concept; and to (2) to external uses involving the costing of inventories, income determination, and financial reporting. The internal uses deal with the application of direct costing in profit planning, product pricing, other phases of decision making, and in cost control. Executive management, including marketing executives, production managers, and cost analysts, has generally praised, control, and analytical potentialities of direct costing. Fixed costs calculated on a unit cost tend to vary. On the other hand, direct unit costs and the contribution margin per unit tend to remain constant for various volume of production and sales.

In cost volume profit Analysis, contribution margin or marginal income is the result of subtracting all variable costs from sales revenue. In direct costing, an income per unit not calculated; only an income on total sales of all products is determined by subtracting the total fixed cost from the contribution margin.

Summary: Variable costing charges products with only those manufacturing costs that vary directly with volume. Only prime costs (direct materials and direct labor) plus variable factory overhead expenses are assigned to inventories, both work in process and finished goods, and to the cost of goods sold.

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