Limitations of Variable Costing - GAAP and External Reports:
Learning Objectives:
- What are the limitations of variable
costing?
- Is variable costing acceptable for
external reports?
- Do financial statements prepared
under variable costing system conform to generally accepted accounting
principles (GAAP)?
Practically speaking,
absorption costing is required for external reports in United
States and almost all over the world. A company that attempts to
use
variable costing (also called direct costing and marginal
costing) on its external financial reports runs the risk that its
auditors may not accepts the financial statements as conforming to
generally accepted accounting principles (GAAP). Tax laws
almost all over the world require the usage of a form of
absorption costing for filling out income tax forms.
Even if a company must use absorption costing
for its external reports, a manager can use
variable costing statements for internal reports. No particular
accounting problems are created by using both costing methods--the variable
costing method for internal reports and the absorption costing method for
external reports. The adjustment from variable costing net operating
income to absorption costing
net operating income is a simple one that can be easily made at
year-end.
Top executives are typically evaluated based
on the earnings reported to shareholders on the external financial reports.
This creates a problem for top executives who might otherwise favor using
variable costing for internal reports. They may feel that since they are
evaluated based on absorption costing reports, decisions should also be
based on absorption costing data.
|
Absorption Costing
Around the World: Absorption costing is norm around the world
for external financial reports. After the fall of communism, accounting
methods were changed in Russia to bring them into closer agreement with
accounting methods used in the west. One result was the adoption
of absorption costing |
|
