Answer to Question #306731 in Marketing for sammy

Question

The market research has also shown that the product will attract more customers and raise large amount of revenue to the firm in the future. However, there is always a debate within the company accounting department on how to calculate the performance (profit). The chief financial accountant believes that absorption costing does a better job of matching costs with revenues thus presents more accurate profit figure than variable costing.Whether you agree or not with the argument of the chief financial accountant. Why or why not?

Answer 1

Absorption costing, also known as full costing, entails allocating fixed overhead costs across all units produced for the period, resulting in a per-unit cost. Variable costing includes all of the variable direct costs in Cost of goods sold(COGS) but excludes direct, fixed overhead costs. Yes, it’s true that absorption costing does a better job of matching costs with revenues. Absorption costing involves allocating all of the direct costs associated with manufacturing a product to COGS. This includes any variable costs directly associated with manufacturing like; cost of raw materials, hourly cost of labor, salaries of manufacturing workers, variable costs of electricity used to run a plant in manufacturing mode. It also includes any direct, fixed costs like; the mortgage payment on a building used for manufacturing, insurance on a manufacturing property, depreciation on a manufacturing machine.

Depending on a company’s level of transparency, an income statement using absorption costing may break out variable direct costs and fixed direct costs into two line items or combine them together to report a comprehensive COGS. Always, the variable direct costs and fixed direct costs are subtracted from revenue to arrive at the gross profit which gives a more accurate profit figure. The absorption costing method is normally the standard for most companies with COGS. It is required for compliance with Generally Accepted Accounting Principles(GAAP). Most auditors and financial stakeholders will also require it for external reporting. Depending on the type of business structure, small businesses may also be required to use absorption costing for their tax reporting.