Variable Costing
A cost accounting method that treats only variable manufacturing costs as product costs.
What is Variable Costing?
Variable costing (also called direct costing or marginal costing) is a method of product cost accounting in which only variable manufacturing costs — direct materials, direct labor, and variable overhead — are included in inventory cost. Fixed manufacturing overhead is treated as a period cost and expensed in full in the period incurred, rather than being absorbed into inventory. This approach contrasts with absorption costing (required under GAAP for external reporting), where fixed overhead is allocated to units produced. Variable costing is widely used for internal management decisions because it aligns cost behavior with output and makes the contribution margin clearly visible, aiding break-even analysis and pricing decisions.
Example
A company producing 10,000 units has variable manufacturing costs of $20 per unit and fixed overhead of $100,000. Under variable costing, each unit costs $20 and the full $100,000 in fixed overhead hits the income statement immediately. Under absorption costing (GAAP), each unit costs $30 ($20 + $10 allocated fixed overhead) — so if 8,000 units are sold, $20,000 of fixed overhead remains in ending inventory, deferring expense recognition.