Absorption (Full) and Variable Costing Contrasted

It should be noted that, in order to 'attach' costs that remain fixed in relation to volume to individual products (in order to calculate an absorption or full cost) it is necessary to treat fixed costs as if they were variable and charge them out on a rate dividing fixed costs between units of production. Any change in production volume would therefore alter the appropriate fixed overhead charging rate per unit and consequently the full cost calculated. A variable costing approach avoids this illogical situation, but it must be remembered that, in the long-run, fixed costs must be paid for out of the surplus generated from selling products, less the variable costs associated with producing those products.

Contribution Towards Fixed Costs

Where a product has a fixed selling price per unit, and a fixed amount of variable costs are needed to produce each unit, the net amount (selling price - variable costs) will also be a fixed amount per unit. This amount is termed the product's contribution - the amount each unit of the product sold contributes towards fixed costs and profit (once fixed costs have been covered).

Selling Price per unit - Variable Cost per unit = Contribution per unit

or

Sales - Variable Costs = Contribution