Direct Costing | Marginal Costing

Variable Costing

Inventory valuation

Summary of Direct Costing. Abstract

The Direct Costing method (also: Variable Costing or Marginal costing) is an inventory valuation / costing model that includes only the variable manufacturing costs:

Direct materials (those materials that become an integral part of a finished product and can be conveniently traced into it)
Direct labor (those factory labor costs that can be easily traced to individual units of product. Also called touch labor)
Only variable manufacturing overhead

... in the cost of a unit of product. The entire amount of fixed costs are expenses in the year incurred.

Variable Costing is also referred to as the direct costing method or the marginal costing method.

Should Fixed Manufacturing Costs be Included in Inventories?

Advocates of Absorption Costing say it should, because all of the production costs are needed to create the products. Thus, they have "future economic benefits."

Advocates of Variable Costing argue that in order for a fixed manufacturing cost to be an asset, it has to meet a "future cost avoidance" criteria much the same way as prepaid insurance. In the case of fixed manufacturing costs, they do not meet this criteria because they are incurred each time the production line opens. Thus, they need to be expenses in that period and only variance expenses inventoried.

Consequences of using Variable Costing for Profit calculation

The difference is important for calculating profit when a beginning and ending inventory levels are different:

If beginning and ending inventory levels are equal: absorption costing profit = variable costing profit
If inventory levels are run down over the period: variable costing profit will be higher than absorption costing profit
If inventory levels are increased over the period: absorption costing profit will be higher than variable costing profit.

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Compare with Variable Costing: Absorption Costing | Activity Based Costing

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