Variable Costing

Variable costing is a method in which the fixed manufacturing overheads are not allocated to units produced but the whole amount is charged against revenue in the period in which they are incurred. Under variable costing (also called marginal costing), cost of inventories under this method comprises only of variable manufacturing costs i.e. direct materials, direct labor and variable manufacturing overheads.

Unlike absorption costing, in which fixed manufacturing overheads are allocated to each unit produced and reflected in the cost of inventories on balance sheet, in variable costing no fixed manufacturing overheads are traced to units.

Variable costing income statement

Variable costing income statement has the following line items:

LessVariable production costs
LessVariable selling & admin costs
EqualsContribution margin
LessFixed manufacturing overheads
LessFixed selling & admin costs
EqualsNet income

Variable production costs include direct materials, direct labor and variable manufacturing overheads.

Contribution margin is the amount contributed by sales towards fixed costs and profit.

Absorption costing vs variable costing

In variable costing, costs are bifurcated into variable and fixed categories regardless of whether they are product costs or period costs, while in absorption costing they are categorized into product costs and period costs regardless of whether they are variable or fixed in nature.

Difference between net income under absorption costing and net income under variable costing arises because in absorption costing fixed manufacturing overheads are included in the cost of inventories and subtracted from revenue for the period in which those inventories are sold, while in variable costing total manufacturing overheads are subtracted in the period in which they are incurred.

Net income under absorption costing can be reconciled with net income under variable costing as follows:

Absorption costing net income
LessFixed manufacturing overheads included in closing inventories
AddFixed manufacturing overheads included in opening inventories
EqualsVariable costing net income


Let's work with the data given in example for absorption costing.

Following information is for XYZ Ltd for the financial year ended 30 March 2015:

Price per unit$4.5
Units in opening inventories3,000
Units produced during the year22,000
Units in closing inventories ,000
Direct materials$2,000
Direct labor3,000
Variable manufacturing overheads1,000
Fixed manufacturing overheads1,500
Total cost of opening inventories7,500
Direct materials for the period$16,100
Direct labor for the period22,000
Variable manufacturing overheads for the period11,000
Fixed manufacturing overheads for the period13,200
Total manufacturing cost for the period62,300
Variable selling & administrative expenses for the period$4,400
Fixed selling & administrative expenses for the period$10,000

Calculate net income under variable costing.


Units sold (3,000 + 22,000 - 4,000)A21,000
Price per unitB4.5
Total revenueC = A × B94500
Opening inventories (2,000 + 3,000 + 1,000)D6,000
Manufactured units (16,100 + 22,000 + 11,000)E49,100
Closing inventories (49,100/22,000 × 4,000)F8,927
Variable product costsG = D + E - F46,173
Variable selling & administrative expensesH4,400
Total variable costsI = G + H50,573
Contribution marginJ = C - I43,927
Fixed manufacturing overheadsK13,200
Fixed selling & admin costsL10,000
Net incomeM = J - K - L20,727


Variable costing is used for managerial analysis because:

  1. It categories costs into variable and fixed components which helps in cost-volume-profit analysis.
  2. It helps in making decisions regarding accepting or rejecting special orders.
  3. It does not affect net income due to fluctuations in inventory levels.
  4. It helps in preparing flexible budgets for better variance analysis.

Written by Obaidullah Jan, ACA, CFA <--- Hire me on Upwork