Fixed costs, Variable costs & Contribution 1

	management
	Accounting: Fixed costs, Variable costs & Contribution

Fixed Costs, Variable Costs and Contribution

Absorption (or Full) Costing

Last section we examined the classification system frequently employed in cost accounting systems to routinely 'attach' production costs to products to provide stock values for financial reporting purposes. This classification system was seen to be based on a logic of 'matching' whereby products costs should include all manufacturing costs (both direct and indirect) so that those costs can be carried forward in stock values to be matched to the revenues earned in the accounting period when the products are finally sold. For stock valuation, non-manufacturing costs are all treated as expenses of the accounting period in which they were incurred, and not 'attached' to products.

(For other purposes non-manufacturing costs are sometimes also 'attached' to products). A system that 'attaches' all costs to a particular 'cost objective' is termed an absorption or full costing system.

Variable (Marginal or Direct) Costing

An alternative approach to cost classification which is more useful for managerial decision-making analyses is based on a logic of cost behaviour - the behaviour of cost as a function of activity or output (units produced and sold or sales value). A variable costing approach seeks to 'attach' to products only those costs that are directly variable with output, leaving all costs that remain unaffected by output level (fixed costs) as period, rather than product costs.