Chapter 16, Problem 1RQ

What are the advantages of the contribution margin format based on variable costing compared to the traditional format based on full absorption costing?

To determine

Explain the advantages of contribution margin based on variable costing compared to the full absorption costing.

Explanation of Solution

Variable costing:

Under variable costing format, the fixed cost is used as the period cost and does not vary with the volume of production of units.

Absorption costing:

Under absorption costing, manufacturing costs incurred are allocated to the units produced by a particular company. In this method, the cost of goods manufactured includes direct materials, direct labor, and factory overhead costs. Fixed factory overhead and variable factory overhead are included as a part of factory overhead.

The advantage of using contribution margin format over traditional format:

Under absorption costing, the fixed costs are allocated to the units based on per unit basis. In case, when all the units produced are sold, then the whole fixed cost will be charged to the revenue or profit earned. In order to spread the fixed cost to more production units allocated towards the inventory as the variable costing. In this process, inventory is ignored while calculating contribution margin. Thus, unnecessary production of goods can be eliminated. Hence, the contribution margin format is more advantageous when compared to the traditional format based on absorption costing.