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costing methods - absorbtion and variable costing

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Introduction

Absorption Costing includes Direct materials, direct labour and Manufacturing overhead (both variable and fixed). Absorption costing treats all production costs as product costs, regardless of whether they are variable or fixed. Under absorption costing, a portion of fixed manufacturing overhead is allocated to each unit of product. Variable costing includes only variable production costs in product costs. Direct materials, direct labour and variable manufacturing overhead costs. Fixed manufacturing overhead is not treated as a product cost under this method. Rather, fixed manufacturing overhead is treated as a period cost and is charged against income each period. "Variable costing distinguishes between fixed cost and variable cost" ( IPA 2004, cost accounting) The distinction between absorption and variable costing is based on the treatment of fixed overhead. Using absorption costing method, fixed overhead assigned to units of inventory is shown in the income statement as part of the cost of goods sold. When units are produced and not sold, fixed overhead stays in finished goods inventory. Under variable costing, reported operating income is driven by the unit level of sales. ...read more.

Middle

Absorption costing is the method required by tax regulation. "Marginal costing net profit reacts to changes in saes volume only : absorption costing net profit react to changes both in sales and in stock volumes" (Alan Upchurch, 2002. P.336). The difference between the two income-measurement approaches is essentially the difference in the timing of the charge to expense for fixed factory-overhead cost. Operating income is a function of both sales and production. Question (ii) Although tax regulations require manufacturing companies to use an absorption costing system, I agree the most appropriate method is variable costing. it is easier to understand variable costing reports For internal reporting and control purposes, because data are organized by behaviour and variable costing is closer to net cash flow than absorption costing net operating income. Variable costing does not allow the capitalization of fixed overheads on stocks that cannot be sold. A more practical approach - If Units produced = 2,000, units sold = 1,800, contribution margin ratio is 37%, fixed S & A expenses are �90,000, Fixed mfg, Expenses are �80,200 hence net income greater under absorption costing than variable costing by �8,020 (bogus figure). ...read more.

Conclusion

The supply and demand model determines price and quantity sold in the market. Excess demand puts upward pressure on price and Excess supply puts downward pressure on price, the demand, supply and prices are the outcome of the decision of people. Law of demand and supply states that , other things being equal, the demand for a commodity or service will decline if the price is raised and will rise if the price is reduced(IPA, 2004, economics stage 2, p.17...) For example the price for Heinz bake beans is higher than other Baked beans such as Tesco, dunes and lidl, despite the competition with these other products, Heinz manage to keep its price high due to the quality of the food. With regard to Heinz baked beans, competition is not the only variable in pricing decision Pricing is essential to the overall profitability of the organization. Effective pricing, however, requires a systematic approach starting with a review of the objectives of the company, you're the product or service will have a significant impact on Price decisions, Understanding the characteristics of the marketplace is an essential factor in establishing a price, characteristics of the product will influence the price also environmental factors . ...read more.

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