Variable or Direct Costing

Variable costing is very important element of cost and management accounting. Variable costing charges products with only those manufacturing costs that vary directly with volume. Only prime costs (direct materials and direct labor) plus variable factory overhead expenses are assigned to inventories, both work in process and finished goods, and to the cost of goods sold. Thus, these variable costs are charged to the product while fixed manufacturing costs are totally expensed in the current period. Manufacturing costs such as depreciation, insurance, and taxes that are a function of time rather than of production are excluded from the cost of the product. Also excluded are salaries factory supervisors and office employees as well as wages of certain factory employees, such as maintenance crews and guards, which are considered period costs rather than product costs.

Direct costing focuses attention on the product and its costs. This interest moves in two directories: (1) to internal uses of the fixed variable cost relationship and the contribution margin concept; and to (2) to external uses involving the costing of inventories, income determination, and financial reporting. The internal uses deal with the application of direct costing in profit planning, product pricing, other phases of decision making, and in cost control. Executive management, including marketing executives, production managers, and cost analysts, has generally praised, control, and analytical potentialities of direct costing. Fixed costs calculated on a unit cost tend to vary. On the other hand, direct unit costs and the contribution margin per unit tend to remain constant for various volume of production and sales.

In cost volume profit Analysis, contribution margin or marginal income is the result of subtracting all variable costs from sales revenue. In direct costing, an income per unit not calculated; only an income on total sales of all products is determined by subtracting the total fixed cost from the contribution margin.

The concept of zero based budgeting was introduced in 1960. The concept was initially used for some government and business organizations and more recently has increased attention. Zero based budgeting is a budget-planning procedure for the reevaluation of an organization’s program and expenditures. It requires each manager to justify the entire budget request in detail and places the burden of proof on the manager to justify why authorization to spend any money at all should be granted. It starts with the assumption that zero will be spent on each activity-thus the term “zero base”. What a manager is already spending is not accepted as starting point. Managers are asked to prepare for each activity or operation under their control a “decision package” that includes an analysis of cost, purpose alternative course of action, measure of performance, sequences of not performing the activity, and benefits. The zero based budgeting approach asserts that in building the budget from zero, two types of alternative should be considered by managers: (1) different ways of performing the same activity and (2) different levels of effort in performing the activity. Success in implementing zero based budgeting requires linkage of zero based budgeting to the long range planning process, sustained support and commitment from executive management, innovation among the managers who makeup the budget decision packages, sale of the procedure to people must perform the work necessary to keep the concept vigorous. Sound budgeting procedure should always require a careful evaluation of all operating facts each time the budget is prepared. There fore the zero based budgeting procedure is new and unique mainly in approach rather than in basic planning and control philosophy.

Rashid Javed is an Asian author. He writes articles about various topics of financial accounting and managerial accounting such as debt to equity ratio and contribution margin
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