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Variable Costs
Variable costs are expenses that are prone to changes due to change in economic activities. This means that the value assigned to these expenses can go either up or down depending on the activities of an enterprise. If a business experiences more sales, the owner of that business will have to purchase more materials to meet the market demand. In such a case expense will increase because more money will be used to buy the raw materials needed for the manufacturing of goods (Weygandt, Kimmel, & Kieso 998).
On the other hand, if a business experiences a decline in sales, expenses will come down because the money that would have been used is reserved for other uses. It is said that variable costs swell with an increase in a source of revenue and vice versa. Capon explains that the logic behind this argument is that as more money is generated, it has to be spent to buy the things that made it possible for the enterprise to make money in the first place (517). Wise people say that money has to be used to make money.
Pros and Cons of Variable costs
Variable expenses enable businesspeople to plan for future changes to incur profits. The economy changes drastically hence variable costing caters for any upcoming expenses. In variable costing, the items do not have a constant figure. This means that the profits will not be limited as one would expect.
The disadvantages of variable costs include denial by external bodies to have financial records presented based on the concept of direct expense. This is because they can be easily manipulated compared to full expenses. Securities and Exchange Commission rejects reports that are prepared based on direct costs.
Absorption Costs
Absorption costs comprise all expenses used in completing a product and it is inclusive of variable costs. According to Weygandt, Kimmel, and Kieso, some of the expenses that are put under this category include the money spent on purchasing raw materials, transport used to ferry the materials to their destination plus the money spent on paying workers (999). This kind of costing is mostly used in organizations that present their financial statements to external agencies. If all the monies used in making an item were not accounted for, the expenses would automatically be transformed into variable costs.
For absorption expenses to be reliable, every single cent spent by an organization should be accounted for to eliminate reasons of doubt. This means all money that is used in completing a given task should be held accountable. To an individual, this practice of storing information is very important because it makes us be able to plan for future productions as opposed to when we do not know the exact amount that would be needed to finish a particular product.
Pros and Cons of Absorption Costs
Various benefits come with absorption costs. The first benefit of this cost is that it acknowledges the importance of having fixed costs in making items. In this kind of cost, one cannot come up with changes that are not explained. When manufacturers want to make a product they do their analysis well to ensure that money has been set aside to support the completion of certain tasks. In other words, every single cent spent apart from the money that has been, isolated is viewed as an absorption cost.
Absorption costing is normally preferred by the inland authority because the value assigned to stocks is constant. Besides, the costing is applied in a majority of other institutions because for all money spent there must be records that can be referred to in a bid to make transparent financial records. If the manufacture of items continues to flood the market while the sales come down, the business will not be affected because the money obtained is reserved for other uses.
However, this kind of evaluating costs is not an appropriate method because the cost is bound to change due to the influence of changes that cannot be prevented. For instance, project managers would be misguided if they prepared budgets with fixed amounts which means any costs that may arise will not be attended to. Allocating funds based on absorption may lead to some tasks being overlooked.
Conclusion
Therefore, if I were to open a business today, I would go for variable costs because even if the market price is reduced for my products, I can still wait. This is because I am certain that we have never had a stable economy and thus commodity prices may rise and fall tremendously. Variable costing would also help in planning for future risks concerning change in market conditions.
Works Cited
Capon, Noel. Managing Marketing in the 21st Century, New York: Essex Publishing, 2008. Print.
Weygandt, Jerry, Paul Kimmel and Donald Kieso. Accouniting Principles. 9th Ed. New Jersey: Wiley, 2008. Print
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