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Absorption and Variable Costing

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Introduction

Definition of Absorption and variable costing

In the field of accounting, variable costing which is also referred to as direct costing and absorption which entails full costing are two different terms as long as production in the IBM manufacturing company is concerned. They are two dissimilar methods that are used during the application of production costs to services or products (Narasimhan, 2017). The major difference between the two methods appears in the cases of treating fixed overhead costs for manufacturing. Variable costing involves all the fixed manufacturing overhead costs expensed within the period they incurred whereas, absorption costing method involves all the fixed overhead costs for manufacturing being expensed in the IBM selling its products (Terzioglu & Chan, 2013).

Variable cost system is applicable where there are direct costs and a variable Manufacturing overhead costs that are set for the products at the end. These are costs that move with the product that IBM Company is manufacturing via the accounts of inventory up to time the product will be marketed and sold (Terzioglu & Chan, 2013). These costs are expensed on the IBM's company statements of income as real costs of goods being sold by the company (Narasimhan, 2017). On the other hand, there are fixed manufacturing costs of overhead that are accounted to be expensed for the period they incurred. Variable costing in some cases are known as Marginal Costing.

Absorption costing method in the case of IBM Company applies in situations where there are fixed, variable and all direct costs overheads are involved for manufacturing to end product the company is dealing with. All the above costs are supposed to move with engineering product the IBM Company is manufacturing via all inventory accounts of company till the time the product will be sold (Terzioglu & Chan, 2013). At this point of selling the product, all the cost is expensed on the statements of income as the cost of the products being sold by IBM Company. It is the responsibility of the financial leader of IMB Manufacturing Company to add value to the product. In the process of adding the value, there are several criteria to be followed. Firstly, management of the costs should be commencing as soon as possible as well as reduction of costs on the way to add the value to product. Almost all the successful companies in the world including the IBM Manufacturing Company have incorporated into use of the two costing methods of variable and absorption costing (Narasimhan, 2017).

Absorption costing and variable costing in the IBM Manufacturing Company cannot be substituted for one another due to the fact that both systems have own limitations and own benefits. The information that is specifically provided by method of variable costing applies mostly in internal management of IBM Companies as used in the making of sound decisions. Whereas absorption costing provides significant information for the internal management of the company as well as it helps the external parties such as the auditors, government agencies and creditors. The IBM Company has maximized the opportunities of the both methods of costing in the computation of unit product (Terzioglu & Chan, 2013). Under the costing system of absorption, cost of products consists all fixed manufacturing and all variables too. This involves the direct materials for the company like factory overhead and direct labor (Narasimhan, 2017). But in cases where variable costing system is used, both non manufacturing and manufacturing fixed cost is treated as a capacity cost and hence not included in the product cost.

Effects of absorption costing on IBM Company

Basically, a company always has a choice on which type of costing method to use in their accounting system. Each of the chosen costing methods has advantages and disadvantages. The main objective of these costing methods is calculation of profits accurately. The overall performance of a company is usually determined by sound accounting systems. The effects of absorption costing can either be positive or negative as outlined below.

The use of absorption costing will improve the company's performance since the method is accepted according to the Generally Accepted Accounting Principles (GAAP) (Pratt, 2016). As a result, the company will be able to calculate its actual profit since the method incorporates the calculation of taxes. Moreover, absorption costing considers all costs associated with production. These costs include fixed costs and other overhead costs incurred during production. Analysis of all costs will generally assist the management in budgeting and determination of the actual selling price. Hence, the company will improve its profitability.

However, absorption costing may have some adverse effects on the company. The method can mislead the management in making various decisions. This is due to the fact that the method at times may provide wrong profits. Owing to these fact the company may make decision based on the predicted profits which in turn may occasion the company big losses. The difference between the calculated profit and the actual profit is caused by elimination of some fixed costs during absorption costing (Narasimhan, 2017). These respective costs according to the method are accounted for once the respective product is sold. Investors may be misled by the projected profits which may in turn affect the company's reputation of the company to third parties.

Effects of marginal costing in IBM Company

Marginal costing will generally improve the company's cost management. The method is ideal for production companies since it will enable the company to trace the costs associated with production. Cost management will be easier since unnecessary fixed costs will be eliminated through the method since it considers the costs associated with the production of each unit ( Pratt, 2018). Hence, the management will be able to control all the costs since they will be able to detect any variances. As a result the profitability of the company will be improved since costs will be monitored.

Moreover, the method will improve the efficiency company's operations. This is due to the fact that it is simple and can be used together with other forms of costing methods such as budgeting and standard costing (Narasimhan, 2017). To the accountant of the company, preparation of annual accounts will be easy. Hence, the management will be able to receive financial reports on a timely basis. According to the management in IBM this will be a great achievement since timely decisions.

References

Narasimhan, M. S. (2017). Absorption vs. Marginal Costing. Plank, P. (2018). Introduction. In? Price and Product-Mix Decisions Under Different Cost Systems? (pp. 1-5). Springer Gabler, Wiesbaden. Pratt, J. (2016).? Financial accounting in an economic context. John Wiley & Sons. Terzioglu, B., & Chan, E. S. (2013). Toward Understanding the Complexities of Service Costing: A Review of Theory and Practice. Journal of Applied Management Accounting Research, 11(2), 29.

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