Costing Method Calculator (Absorption vs. Variable)
This calculator demonstrates the difference between Absorption Costing (Full Costing) and Variable Costing (Marginal Costing).
Enter your product cost, sales, and production data for a single period to see how each method treats fixed manufacturing overhead, leading to different product costs and net operating incomes.
Enter Period Data
Understanding Absorption vs. Variable Costing
What is Absorption Costing?
Also known as "full costing," this method treats all manufacturing costs—including direct materials, direct labor, variable overhead, and fixed manufacturing overhead—as product costs. This is the method required by GAAP and IFRS for external financial reporting.
Absorption Cost/Unit = DM + DL + V.MOH + (Fixed MOH / Units Produced)
What is Variable Costing?
Also known as "marginal costing," this method treats only variable manufacturing costs—direct materials, direct labor, and variable overhead—as product costs. Fixed manufacturing overhead is treated as a period cost and is expensed in full in the period it is incurred.
Variable Cost/Unit = DM + DL + V.MOH
The Key Difference: Treatment of Fixed Manufacturing Overhead
The sole difference lies in how fixed manufacturing overhead (Fixed MOH) is handled. Under absorption costing, a portion of Fixed MOH is "attached" to each unit produced. If a unit is not sold, its share of Fixed MOH remains in inventory on the balance sheet. Under variable costing, all Fixed MOH is expensed immediately on the income statement, regardless of how many units are sold.
10 Examples & Scenarios
Explore how different situations impact the results of each costing method.
Example 1: Production = Sales
Scenario: A company produces 10,000 units and sells 10,000 units. There is no change in inventory.
Inputs: DM $10, DL $15, V.MOH $5, Fixed MOH $100k, S&A (V $3/u, F $50k), Price $50, Produced 10k, Sold 10k.
Result: Absorption Net Income will be equal to Variable Net Income. This is because all the fixed MOH capitalized into products during the period is expensed through Cost of Goods Sold in the same period. No fixed MOH is deferred in inventory.
Example 2: Production > Sales (Inventory Increases)
Scenario: A company produces 10,000 units but only sells 8,000 units. Inventory increases by 2,000 units.
Inputs: DM $10, DL $15, V.MOH $5, Fixed MOH $100k, S&A (V $3/u, F $50k), Price $50, Produced 10k, Sold 8k.
Result: Absorption Net Income will be higher than Variable Net Income. Under absorption costing, the Fixed MOH attached to the 2,000 unsold units ($100,000 / 10,000 units = $10/unit * 2,000 units = $20,000) is deferred in inventory. Variable costing expenses the entire $100,000 of Fixed MOH immediately.
Example 3: Production < Sales (Inventory Decreases)
Scenario: A company produces 8,000 units but sells 10,000 units, drawing 2,000 units from beginning inventory.
Inputs: DM $10, DL $15, V.MOH $5, Fixed MOH $100k, S&A (V $3/u, F $50k), Price $50, Produced 8k, Sold 10k.
Result: Absorption Net Income will be lower than Variable Net Income. Under absorption costing, the Fixed MOH from the current period ($100k) PLUS Fixed MOH from the 2,000 units sold from inventory are expensed. Variable costing only expenses the current period's $100k of Fixed MOH.
Example 4: High Fixed Costs
Scenario: An automated factory has very high fixed costs (e.g., depreciation on robots) but low variable costs.
Inputs: DM $2, DL $3, V.MOH $1, Fixed MOH $500k, S&A (V $1/u, F $200k), Price $40, Produced 20k, Sold 15k.
Result: The difference between absorption and variable income will be very large when production and sales differ. The high Fixed MOH per unit ($500k / 20k = $25/unit) means a significant amount of cost is deferred in inventory under absorption costing.
Example 5: Zero Production
Scenario: The factory is shut down for the month, producing 0 units but selling 5,000 from existing inventory.
Inputs: (Assume costs from prior period for inventory) Fixed MOH $100k, S&A (F $50k), Units Produced 0, Units Sold 5,000.
Result: The calculator will show an error for dividing by zero units produced. Conceptually, absorption costing would release previously deferred fixed costs from inventory, while variable costing would show a large loss due to expensing all current period fixed costs with no production to absorb them.
Example 6: Evaluating a Special Order
Scenario: A customer offers to buy 1,000 units for $35 each. Should the company accept? The company has excess capacity.
Inputs: DM $10, DL $15, V.MOH $5, V.S&A $3. Total Variable Cost = $33/unit.
Result: Variable costing is superior for this decision. Since the offer price ($35) is greater than the total variable cost to produce and sell the unit ($33), the order is profitable and contributes $2 per unit towards fixed costs. An absorption cost per unit (e.g., $40) might misleadingly suggest the order is unprofitable.
Example 7: CVP Analysis
Scenario: Finding the breakeven point.
Result: Variable costing is essential for Cost-Volume-Profit (CVP) analysis. The income statement format (Sales - Variable Costs = Contribution Margin - Fixed Costs = Net Income) allows you to easily calculate the breakeven point (Total Fixed Costs / Contribution Margin per Unit). This is difficult with an absorption costing statement.
Example 8: Impact of Overproduction
Scenario: A manager, whose bonus is based on absorption costing net income, increases production from 10k to 15k units, while sales remain at 8k units.
Inputs: DM $10, DL $15, V.MOH $5, Fixed MOH $100k. Initial Production 10k, New Production 15k, Sales 8k.
Result: Increasing production lowers the fixed MOH per unit ($100k/10k = $10 vs $100k/15k = $6.67). Even though sales haven't changed, building up inventory allows the manager to report a higher net income under absorption costing, a potentially dysfunctional incentive.
Example 9: Service Business
Scenario: A consulting firm with no inventory.
Result: The distinction is less relevant as service businesses typically have no inventory. In this case, "units produced" would equal "units sold" (e.g., billable hours delivered), and both methods would yield the same net income.
Example 10: Lean Manufacturing (JIT)
Scenario: A company using a Just-In-Time (JIT) inventory system.
Result: In a JIT environment, inventory levels are minimal or zero. Therefore, units produced are approximately equal to units sold each period. The differences between absorption and variable costing income become negligible, and the two methods can be used interchangeably.
Frequently Asked Questions
1. What is the fundamental difference between absorption and variable costing?
The only difference is the treatment of fixed manufacturing overhead (Fixed MOH). Absorption costing includes it as a product cost (it goes into inventory). Variable costing treats it as a period cost (it's expensed immediately).
2. Why do the two methods result in different net incomes?
The incomes differ whenever the number of units produced is not equal to the number of units sold. This is because absorption costing defers or releases Fixed MOH from inventory as inventory levels change, while variable costing expenses all Fixed MOH in the period incurred.
3. If production equals sales, what happens?
Absorption net income will be exactly equal to variable net income. There is no change in inventory, so there is no Fixed MOH deferred or released.
4. Which method is required for external reporting (GAAP/IFRS)?
Absorption costing is required for external financial statements. This is because the matching principle requires that all costs necessary to produce a product be matched against the revenue from its sale.
5. If absorption costing is required, why learn about variable costing?
Variable costing is considered far superior for internal decision-making. It provides a clearer picture of cost behavior and is essential for analyses like breakeven points, setting special order prices, and making outsourcing decisions.
6. What is "Contribution Margin"?
Contribution margin is a key concept in variable costing. It's calculated as Sales Revenue minus all Variable Costs. It represents the amount of money available to "contribute" to covering fixed costs and then generating a profit.
7. How does this calculator handle beginning inventory?
This calculator is designed for a single period and assumes zero beginning inventory for simplicity. The reconciliation logic works by calculating the change in inventory (Units Produced - Units Sold) during the current period only.
8. What is the "Fixed MOH death spiral"?
This is a dangerous situation where demand falls, causing production to be cut. Under absorption costing, cutting production increases the Fixed MOH allocated per unit. If prices are based on this higher cost, they may be raised, further reducing demand, and creating a vicious cycle.
9. Can variable costing be manipulated?
It is less susceptible to manipulation through production volume. Since Fixed MOH is expensed regardless, a manager cannot increase profit simply by overproducing and building inventory, which is a known issue with absorption costing.
10. What are "product costs" and "period costs"?
Product costs are costs that are attached to a unit of product and are expensed only when the unit is sold (e.g., direct materials). Period costs are expensed in the period they are incurred, regardless of sales (e.g., rent for the corporate office).
