According to Sherrie (2015), variable costing has become paramount in decision-making. Today, managers are using variable costing to make strategic decisions. Many managers argue that variable costing is the best in internal reporting. Variable costing does not consider manufacturing overhead when reporting items in the income statement. When making strategic decisions, fixed costs are not taken into account because they are irrelevant. Fixed costs do not change when the level of volume changes which allows companies to report high revenues. Managers who use the variable costing model when selling additional units are more likely to report higher profits. A company will gain high earnings when using variable costing because the extra unit sold will not call for any extra costs. Unlike absorption-costing, variable costing does not consider fixed manufacturing overhead because they do not change when the level of volume increases or decreases. Today, managers use the variable costing model to determine which product to continue with or discontinue. When making these decisions, managers only consider variable costs, which are deemed relevant in short-term decision-making.
Variable costing is a method of cost accounting that is used in decision-making. Variable costs are expenses that can be traced in the final product. They are affected by the level of volume. For instance, when the level of input increases, variable costs are also expected to increase in the same proportion. Many variable costs in shoe manufacturing determine the cost of the final product (Wink & Corradino, 2010, p. 51). These costs can be either fixed or variable.
Variable costing is used to determine the cost of shoes by eliminating all the fixed costs. It is important to note that the total variable costs change while the unit variable cost remains constant. The variable cost in shoe manufacturing includes, but is not limited, to employee salaries, direct material cost and sales commission.
Employee salary is a variable cost because it changes with changes in volume. There are fixed and variable costs in employee salaries. For instance, the wages paid to production supervisors are fixed costs because they remain stable each month. Moreover, they are not directly affected by the level of output regardless of the number of hours worked. However, hourly production wages are variable costs affected by the level of volume. For instance, in order to increase the number of shoes produced per day, a company will either increase the number of workers or incur overtime expenses. In any case, the cost of wages will be directly affected by the level of volume. This shows that hourly employee pay is a variable cost. According to Wink and Corradino (2010), variable costs respond directly to changes in the level of volume. The directly fixed cost wages represent compensation paid to workers that cannot be traced to the final product but affect production. When using the variable costing method, the indirect wages will appear after the direct variable costs have been added to the cost of the shoes.
Direct material cost is a variable cost because it is affected by the level of output. To increase the volume of shoes manufactured each day, Samanta will have to increase the direct material used in production. Direct material cost includes the cost of raw materials used during manufacturing. Therefore, the direct material is a variable cost that can be traced to the final product. According to Dhavale (2007), direct costs are expenses that can be connected with the final product. Direct material cost is a variable cost because it includes costs of consumable goods that form the final product. Direct material increases and decreases depending on the production level. The cost goes up when the firm produces more shoes and decreases when the company produces few items. Therefore, since the company will reduce the number of raw materials needed during low production, the cost of employees and direct materials will decrease. According to the definition of variable costs, these costs vary proportionately to changes in volume.
Variable direct material cost can be illustrated better in a factory that manufactures cans. A company that produces can use aluminum which is the direct material. The direct material cost can be traced to the cans produced, which makes it a variable cost. In order to increase the number of cans produced, the amount of aluminum will increase proportionally to the level of output. Therefore, the cost of aluminum (direct material) will be a direct cost, which becomes a variable cost.
If Samanta uses the variable costing method, the income statement will still reflect the same revenues as absorption costing. The difference between absorption costing and variable costing is the unit cost of producing a product. In variable costing, all the fixed manufacturing overheads are eliminated. However, absorption-costing uses fixed manufacturing overhead to calculate the cost per unit of the product. Therefore, revenues will remain the same whether managers decide to use absorption costing or variable costing when calculating the income of the company. Differences will only appear in the unit cost due to manufacturing overheads.
Dhavale, D. G. (2007). Product Costing for Decision Making in Certain Variable-Proportion Technologies. Journal Of Management Accounting Research, 19(2), 51-70.
Sherrie, S. (2015). Arguments for variable costing in managerial decision-making. Web.
Wink, G. B., & Corradino, L. J. (2010). Income inflation: absorption costing vs. variable. Journal Of The International Academy For Case Studies, 45(2), 49-54.