Absorption, variable, and throughput costing are three approaches to assigning costs to report income statements in managerial accounting. These approaches differ in the ways they treat products and cost periods. For example, external reporting is usually based on absorption costing to prepare financial statements, which implies accumulating all the costs related to the production of a product. Absorption can be defined as a method of costing that takes into account the allocation of fixed overhead costs across the periods of production (Weygandt et al., 2018). This approach is used to calculate mortgage payments, salaries, raw materials, labor costs, and so on, which improves the cost of goods sold (COGS). A company that has to pay the mortgage to its manufacturing property regardless of its profits provides includes this monthly cost in absorption costing.
For the purpose of internal reporting, the companies can use variable and throughput costing as they are more effective for short-term planning. The key argument for this statement is that fixed costs do not change, and short-term decisions are not associated with indirect material costs. The variable costing method implies treating all costs as inventory costs, while it approaches fixed costs as period costs (Weygandt et al., 2018). This method also means assessing organizational performance for making decisions in the internal environment. The main advantage of adopting the variable method is a low level of business risks in comparison to other costing approaches.
Only variable costs are involved in calculating the planned and actual cost of production. The rest of the costs are fixed costs, to which the fixed part of general production costs, administrative and sales costs are attributed, are not included in the calculation. They are periodically referred to as financial results, meaning that they are taken into account when calculating profit and loss for the period under review. Fixed costs are present regardless of whether the capacity of an organization is loaded or not, or a range of products it produces. Variable costs contribute to production to a greater extent than participate in it. This is why these costs do not depend on the volume of production and are more closely related to a time period.
Compared to absorption and variable methods based on the allocation of indirect costs, throughput costing is an alternative approach to cost management. Throughput is related to the rate at which the system produces target units (Weygandt et al., 2018). If money is considered the target unit in the case of a business enterprise), throughput costing can be understood as the degree at which money is created through the sale of products. Moreover, the emphasis is on the fact that money is earned as a result of sales, not the release of products, which can fully or partially replenish inventories. This costing approach is used in the application of the theory of constraints, which is a methodology of company management, with the key goal to maximize revenue from sales minus the material costs associated with these sales. The throughput can be calculated, for example, for one qualified specialist, one consumed machine-hour, for one square meter of a warehouse, and so on (Weygandt et al., 2018). The examples can also include the costs of subcontracting agreements, customs duties, commissions to sellers, and transportation costs, if an organization does not have its personal product transportation channels.
Reference
Weygandt, J. J., Kimmel, P. D., Kieso, D. E., & Aly, I. M. (2018). Managerial accounting: Tools for business decision-making (5th ed.). John Wiley & Sons.