Business Degree Certification Practice Test

What is the principal difference between variable costing and absorption costing centered on?

1. whether variable manufacturing costs should be included as product costs

2. whether fixed manufacturing costs should be included as product costs

3. whether fixed manufacturing costs and fixed selling and administrative costs should be included as product costs

4. none of these

The correct answer is: whether fixed manufacturing costs should be included as product costs

The principal difference between variable costing and absorption costing lies in the treatment of fixed manufacturing costs. Under absorption costing, all manufacturing costs, including both variable and fixed costs, are assigned to the product. This means that fixed manufacturing costs are allocated to each unit produced, which can lead to these costs being included in inventory until the product is sold. As a result, this method often affects the gross margin and operating income reported on financial statements. In contrast, variable costing only includes variable manufacturing costs as product costs. Fixed manufacturing costs are treated as period costs, expensed in the period they are incurred, and therefore do not affect inventory valuations. This distinction is crucial for decision-making and financial analysis, as absorption costing can sometimes provide a misleading picture of profitability in periods of fluctuating production and inventory levels. The other options do not accurately capture the core distinction between these two costing methods. Variable costing focuses solely on variable costs, while absorption costing incorporates all manufacturing costs, making option B the clear centerpiece of the difference.