Recognizing Production Costs

Recognizing Production Costs

1. Direct Costs

   • Direct costing is an approach to production cost accounting that relies primarily on the analysis of cost behavior and its contribution to profit determination.
     • Proponents of this costing claim, on the contrary to absorption costing, that all product costs must be associated with production, since fixed indirect manufacturing costs will be incurred even if there is no production.
       • The direct costing method considers fixed production costs as period costs.
         • For inventory valuation, direct costing only considers variable costs.
           • Direct costing can also be seen as an application of the concept of marginal analysis, as it emphasizes the contribution margin to cover fixed costs and profit generation.
       • Advantages
         • There are no fluctuations in the Unit Cost
           • It can be useful in some decision-making decisions, choice of alternatives, short-term profit planning.
             • It makes it easier to obtain the Breakeven Point.
         • Disadvantages
           • The results in seasonal or seasonal business are misleading.
             • The evaluation of inventories is inferior to the traditional one
               • It misleads you into believing that unit costs are lower, and this is false.

2. Absorbing Costs

   • Absorptive costing is defined as the incorporation of all manufacturing costs, both variable and fixed, into the cost of the product.
     • Proponents of this type of costing argue that all manufacturing costs (variable and fixed) are part of the product cost, since they assert that the product cannot be without incurring fixed manufacturing costs.
       • Absorptive costing absorption distributes them among the units produced.
         • Absorptive costing includes both, which this has an impact on the balance sheet.
           • According to the absorption costing method, profits can be changed from one period to another with increases or decreases in inventories, i.e.,profit is increased by increasing ending inventories and, at the same time, decrease it by reduced by carrying out the opposite operation
       • The valuation of work-in-process and production in process and finished finished production is higher than direct costing
         • Advantages
           • Disadvantages
             • It is complex to obtain the breakeven point
               • The accounting records by integrating fixed and variable costs costs, makes it difficult to establishment of the optimal cost-volume-profit combination.
                 • It makes it difficult to provide reliable budgets of fixed and variable costs.
         • Pricing is determined based on production and production and operating costs and variable costs Absorptive or traditional costing is universal, i.e. usable in all cases.
           • The system is accepted by the accounting profession and the tax authorities.