Comparing Absorption and Variable Cost Methods: Debunking Myths and Clarifying Differences

In comparing the absorption and variable cost​ methods, each of the following statements is true​ except:

When inventory increases over the period, variable net income will exceed absorption net income

There are several statements comparing the absorption and variable cost methods. Let’s go through each of them to identify the one that is not true:

1. The absorption cost method includes fixed manufacturing overhead in the cost of a product, while the variable cost method only includes variable manufacturing costs.

This statement is true. The absorption cost method assigns both variable and fixed costs to products, while the variable cost method only assigns variable costs.

2. The absorption cost method can result in higher net income than the variable cost method when production exceeds sales, and lower net income when sales exceed production.

This statement is also true. Since the absorption cost method includes fixed manufacturing overhead in the cost of a product, it can lead to higher net income when production exceeds sales (as fixed costs are spread over a larger number of units), and lower net income when sales exceed production (as fixed costs are spread over fewer units).

3. The variable cost method may be more useful for short-term decision​ making, while the absorption cost method may be more appropriate for long-term decision​ making.

This statement is also true. The variable cost method is useful for short-term decision making because it only considers variable costs that change with the level of output. The absorption cost method, on the other hand, considers fixed costs as well and is more appropriate for long-term decision making.

4. Both the absorption and variable cost methods are not allowed under GAAP and IFRS.

This statement is false. Both the absorption and variable cost methods are allowed under GAAP and IFRS. However, GAAP requires companies to use absorption costing for external financial reporting purposes, while IFRS allows companies to choose between absorption and variable costing methods.

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