Choosing between variable and absorption costing for decision-making

Variable vs. Absorption Costing

Whether to use variable or absorption costing would depend on the type of decisions the information is being evaluated for. Variable costing provides a better understanding of the effects of fixed costs, allows better understanding and ease in using cost control methods, provides information for CVP (cost volume profit analysis), and is closer to cash flows (Variable costing vs. absorption costing, 2012). Absorption costing is used in financial statements, recognizes importance of fixed costs, and shows less fluctuation in net profit when sales or production volumes fluctuate (Advantages and Disadvantages of Absorption Costing System, 2012).

Decisions for competitor pricing is best evaluated under the variable costing to ensure that all costs are paid in a timely manner. Also, decisions based on controlling inventory and production volumes or determining cash flow would best be made with variable costing. Absorption costing can be used for decisions concerning the effects of the fixed costs on financial statement calculations. Each method has its own purpose, benefits, and limitations and are best used in combination based on the decisions at hand to be made.

For the case of Montana Company, the variable product costs are $82,440 (14,490 + 25,530 + 32,420 + 10,000) where the absorption product costs are $72,440 (14,490 + 25,530 + 32,420). If a competitor is submitting a lower bid on product, the variable costing would lead to the best decision to determine an appropriate competitive price. The variable costing represents all costs involved in producing the product and can also evaluate for appropriate cash flow that would be needed for operations.