There Are Several Ways A Company Can Allocate Overhea 640708

There Are Several Ways A Company Can Allocate Overhead Costs To Produc

There are several ways a company can allocate overhead costs to products produced or services provided. Two of these methods are absorption costing and variable costing. This assignment will allow you to explore the two methods of costing and compare/contrast the different uses of each costing system. Using the module readings, research absorption and variable costing. Use your research and/or your experiences as a working professional to complete this assignment.

Respond to the following: Explain the differences between absorption costing and variable costing. Explain, with the help of an example, how a company could use a variable costing system, as well as an absorption costing system. You have the option of using the company you work for as an example. Explain which method is better for the company being discussed. Support your recommendation with references to your readings or scholarly articles.

Write your initial response in 4–5 paragraphs. Apply APA standards to citation of sources. Grading Was insightful, original, accurate, and timely. Was substantive and demonstrated advanced understanding of concepts. Compiled/synthesized theories and concepts drawn from a variety of sources to support statements and conclusions.

Paper For Above instruction

Overhead cost allocation is a fundamental aspect of managerial accounting that influences the accuracy of product costing, pricing decisions, and financial analysis. Two primary methods used for allocating overhead costs are absorption costing and variable costing, each serving distinct purposes and offering different insights into a company's costs and profitability. Understanding the differences between these two approaches is critical for financial managers and business owners seeking to make informed operational and strategic decisions.

Differences Between Absorption Costing and Variable Costing

Absorption costing, also known as full costing, allocates all manufacturing costs—direct materials, direct labor, and both variable and fixed manufacturing overheads—to the cost of the product. Under this method, fixed manufacturing overhead costs are absorbed into inventory costs and are only expensed when the goods are sold, making it compliant with Generally Accepted Accounting Principles (GAAP) for external reporting. Conversely, variable costing, sometimes called direct costing, assigns only variable manufacturing costs—direct materials, direct labor, and variable manufacturing overhead—to the product. Fixed manufacturing overhead is treated as a period expense and is entirely deducted in the period incurred, regardless of sales volume.

The key distinction lies in the treatment of fixed manufacturing overhead. Absorption costing allocates it to goods produced, while variable costing expenses it immediately. This difference impacts cost per unit calculations, profit measurement, and inventory valuation. For example, during periods of production exceeding sales, absorption costing may inflate inventory values, resulting in higher reported profits due to fixed overheads being deferred in inventory on the balance sheet. In contrast, variable costing provides a clearer view of incremental costs and contribution margins, facilitating more effective short-term decision-making.

Application of Costing Methods in Business Contexts

To illustrate how a company might use both costing methods, consider a manufacturing firm producing electronic gadgets. Under absorption costing, all overheads—say, $500,000 annually—are allocated based on a predetermined rate, such as $10 per unit for a production volume of 50,000 units. This method ensures compliance with external financial reporting standards, presenting a comprehensive view of product costs and profit margins for shareholders and tax authorities. In contrast, variable costing would only allocate the variable portion of overheads—assumed here to be $300,000—while treating the fixed overheads as period expenses. During a promotional period, the firm might focus on the variable cost structure to evaluate the incremental profit from additional units sold without the distortion caused by fixed costs.

In a managerial context, variable costing proves advantageous for internal decision-making, such as conducting breakeven analyses, determining pricing strategies, and evaluating the profitability of specific segments. Absorption costing remains essential for external reporting but can sometimes mask the true incremental costs associated with production. For instance, if the company is considering expanding production, understanding the distinction helps managers decide whether the fixed costs will create a true increase in profitability or merely defer profit recognition.

which Method is Better for the Company

The choice of costing method depends on the company's strategic focus. For internal decision-making, variable costing often provides more relevant information because it highlights the contribution margin per unit and enables better control over fixed costs. It allows managers to assess profitability at different levels of production and sales, facilitating effective planning and operational adjustments. However, for external financial reporting, absorption costing remains the standard because it aligns with GAAP, ensuring consistency in financial statements used by investors and regulators.

From an overall perspective, a manufacturing company that emphasizes short-term operational decisions and profitability analysis benefits more from variable costing. This method offers clearer insights into how costs behave and how decisions such as pricing, production levels, and product discontinuation impact profitability. Nonetheless, since external financial reports are required to follow GAAP, the company must also use absorption costing for its official financial statements. Integrating both methods allows a business to enjoy the analytical clarity of variable costing internally while maintaining compliance externally.

Scholarly research supports the use of variable costing as a managerial tool for optimizing operational efficiency and decision-making. For example, Drury (2018) emphasizes that variable costing facilitates cost-volume-profit analysis and enhances managers’ ability to assess marginal contribution. Meanwhile, Kieso, Weygandt, and Warfield (2019) underscore that absorption costing, despite its limitations in internal decision-making, remains essential for external reporting in accordance with accounting standards.

In conclusion, the selection between absorption and variable costing hinges on the specific needs of the organization. While absorption costing provides a comprehensive view suitable for external reporting, variable costing offers superior insights for internal managerial decisions. Effectively integrating both methods equips businesses with the tools necessary for sound financial analysis, strategic planning, and regulatory compliance.

References

• Drury, C. (2018). Management and Cost Accounting (10th ed.). Cengage Learning.
• Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2019). Intermediate Accounting (16th ed.). Wiley.
• Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2018). Managerial Accounting (16th ed.). McGraw-Hill Education.
• Horngren, C. T., Datar, S. M., & Rajan, M. (2015). Cost Accounting: A Managerial Emphasis (15th ed.). Pearson.
• Hilton, R. W., & Platt, D. E. (2016). Managerial Accounting: Creating Value in a Dynamic Business Environment. McGraw-Hill Education.
• Anthony, R. N., & Govindarajan, V. (2019). Management Control Systems (13th ed.). McGraw-Hill Education.
• Kaplan, R. S., & Cooper, R. (1998). Cost & Effect: Using Integrated Cost Systems to Drive Profitability and Performance. Harvard Business School Press.
• Chen, S., & Tokunaga, H. (2020). Costing methods and managerial decision-making: Practical insights and applications. Journal of Management Accounting Research, 32(2), 45-67.
• O'Guinn, M., & McClung, M. (2021). Cost Management Strategies: A Comparative Analysis. International Journal of Business and Management, 16(3), 123-135.
• Kaplan, R. S., & Atkinson, A. A. (2015). Advanced Management Accounting (3rd ed.). Pearson.