Variable absorption and activity based costing systems Essay

In any concern the chief purpose of the company is to maximize the net income in order to run the company for the long term. This takes us to the determination devising which is the most of import portion to maintain an entity running successfully doing good net incomes. Decisions of the direction of a concern really depends on the type of the costing system being adopted by the company, different bing systems ends up with different net income for the period. In different parts different bing systems are adopted by the entities. So taking the right type of the costing system leads the company towards better hereafter. There are three basic attacks to the bing systems named as variable, soaking up and activity-based costing. Variable and soaking up costing system are the general type of the bing systems tends to be seen in medium or little sized company, while activity based costing is more sort of complex costing system. It usually depends on the type of the concern to take suited costing system. But to choose appropriate costing system, direction of an entity should be plenty capable to measure different bing systems under their state of affairs and to buttockss which bing would impact the net income in maximising and the factors related to them.

Evaluation of AC and MC

Before we get into depth analysis of soaking up and fringy costing, it is more of import for us to cognize what really differentiate these two from each other. The chief thing which distinguishes soaking up and fringy costing is the fixed cost. Now if we say it ‘s merely the fixed cost which keeps apart these two systems this is non specific plenty. The cardinal issue is that in AC fixed costs are treated as production costs and therefore a portion of the merchandise ‘s cost where as under fringy bing the fixed cost component is non treated as a portion of the production cost of the merchandise, alternatively it is treated as a period cost and would be written off hence non considered in any sort of stock rating. This consequences in a different net income or loss when a concern analyses its net income for the period in which completed goods stock degree has changed, depending on which bing system is established in the organisation either fringy or soaking up.

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Absorption/Full costing

Absorption costing could be defined in a typical manner as such a costing system in which all the fabrication costs incurred are absorbed by the merchandise ‘s units produced. In other words we could briefly state it apportions portion of all the costs incurred like direct stuff, labor, fixed and variable operating expenses by the concern to each of its merchandises or services. It helps in acknowledging in the long tally whether each merchandise or service makes a net income. Whereas we need to see arbitrary premises about the allotment of the many of the costs which tends to stay fixed during a period, will besides be subjected to the degree of the activity.

An soaking up bing system traditionally classifies costs by map. Gross saless less production costs ( of gross revenues ) measures the gross net income ( manufacturing net income ) earned. Gross net income lupus erythematosus costs incurred in other concern maps establishes the net net income ( operating net income ) earned.

Using an soaking up costing system, the net income reported for a fabrication concern for a period will be influenced by the degree of production every bit good as by the degree of gross revenues. This is because of the soaking up of fixed fabricating operating expenses into the value of work-in-progress and finished goods stocks. If stocks remain at the terminal of an accounting period, so the fixed fabrication operating expense costs included within the stock rating will be transferred to the undermentioned period.

Marginal or variable Costing

A fringy cost is another term for the variable cost.

This term “ fringy ” costing is by and large applied to the variable cost of a unit of merchandise or service, on the other manus the term “ variable cost ” is applied to the cost of stuff, labor and other resource cost.

It is usually defined as a amount of Direct Material costs, Direct Labour, Direct Expenses and Variable Overheads.

Marginal costing could besides be defined as “ an accounting system in which variable costs are ascertained to the cost units and the fixed costs for that period are to the full written off against the cumulative part.

Its particular value is in separating the cost behavior and hence assisting in determination devising.

In determination analysis about a certain merchandise under fringy costing, whether to abandon that product/service or non it is really of import that we merely bring the costs that varies with the determination, like for many determinations that are for comparatively limited period of clip or they involve comparatively little fluctuation from the bing pattern, fixed costs are non comparative to the determination.

The term “ part ” is usually taken as gross revenues monetary value less the variable cost of that unit/product/service.


A company XYZ industries and produces a individual merchandise. In each month 1 and 2 company manufactures 10 units and the criterion cost card of the merchandise is as follow:

Direct Labour: ?30

Direct Material: ?25

Fixed Operating expenses: ?45

Entire Cost: ?100

Each unit made were sold for ?20. All the units made in month 1 were sold while merely 8 units were sold in month 2.


Calculation for cost/unit under fringy and soaking up costing would be as follow ;

Under Marginal Costing

Cost/unit: 55/10 = ?5.5 ( utilizing variable costs merely )

Under soaking up costing

Cost/unit: 100/10 = ?10 ( utilizing all costs )


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