The heart of the difference between variable costing and absorption costing for financial accounting is the accounting for fixed manufacturing costs. All variable manufacturing costs are inventoriable product costs under the both methods. But fixed manufacturing costs are treated differently. Under variable costing, fixed manufacturing costs are treated as expenses of the period. Under absorption costing, fixed manufacturing costs are inventoriable costs. They are then deducted as the costs of goods sold when sales occur.
Since fixed manufacturing costs are excluded in inventoriable product costs under variable costing, it shows a lesser inventory value. In other words, the value of inventory is understated under variable costing.
Unlike that, under absorption costing, product costs are inflated by fixed manufacturing costs. Therefore, inventories are over-stated in absorption costing.
There is a direct relation between the difference in the value of inventory or asset and the net income of the period. Inventory is a current asset. As the size of an asset increases profit also increases and vice-verse.
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Since fixed manufacturing costs are excluded in inventoriable product costs under variable costing, it shows a lesser inventory value. In other words, the value of inventory is understated under variable costing.
Unlike that, under absorption costing, product costs are inflated by fixed manufacturing costs. Therefore, inventories are over-stated in absorption costing.
There is a direct relation between the difference in the value of inventory or asset and the net income of the period. Inventory is a current asset. As the size of an asset increases profit also increases and vice-verse.
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