Absorption vs Variable Costing: Why Does Inventory Change Net Income?
The core difference is where fixed manufacturing overhead goes.
Absorption costing
Product cost includes direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead.
Variable costing
Product cost includes variable manufacturing costs, while fixed manufacturing overhead is treated as a period cost.
Inventory effect
When production exceeds sales, absorption costing can defer some fixed manufacturing overhead in ending inventory, increasing current-period income relative to variable costing.
When sales exceed production
Previously deferred fixed overhead can flow out of inventory, potentially making absorption income lower than variable-costing income.
The takeaway
Absorption costing puts fixed manufacturing overhead into inventory. Variable costing expenses fixed manufacturing overhead in the period.
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FAQ
Does absorption costing include fixed manufacturing overhead in product cost?
Yes.
Does variable costing expense fixed manufacturing overhead currently?
Yes.
Can inventory changes create different operating income?
Yes.