Variable and Fixed Costs in Managerial Accounting

Accounting information aids internal and external users in making sound financial decisions. Financial accounting provides information to external users such as shareholders, financial providers, regulators, and tax authorities, thus is available to the public. Managerial accounting provides information to internal users, for planning, budgeting, and controlling; it is confidential in nature. Moreover, managerial accounting information focuses on the future of the organization by providing management with information for planning and forecasting while financial accounting provides historical data to external user for decision-making and forecasting future performance of the organization.

Managerial accounting reports are regular in nature and computation of the reports occurs whenever needed while financial accounting statements are for a specified period such as a fiscal year (Accounting for Management, 2011.). Financial accounting statements follow Generally Accepted Accounting principles (GAAP’s), while managerial accounting does not have to adhere to any standards (Martin, 2011). In addition, managerial accounting information provides detailed information for use in different departments within the organization while financial accounting statements is a summary of the organizations’ financial activities.

Internal users require financial information to make decisions, formulate policies and strategies for the organization. Different managerial levels in the organizations have different needs for information. Managerial accounting acts as a strategic partner helping management in the functions of planning, directing, leading, controlling, and monitoring the organizations’ activities (Introduction to Managerial Accounting, 2007). The planning process requires adequate information to help management in evaluating various alternatives before making any given decision. Directing involves providing guidance on the organization’s operation; therefore, management requires adequate financial information to carry out this function effectively. Controlling and monitoring of the organizations’ operations should not be arbitrarily; accurate financial information is imperative to ensure the two functions are effective.

Today’s business environment is highly dynamic, and requires managers to have adequate information in order to gain competitive advantage over other players in the industry. Managerial accounting profession goes back to the early days of the eighteenth century. The profession has the role of collecting, summarizing, and presenting financial information to management for competitive decision-making.

Managerial accounting professionals play a critical role in the modern organization by supporting decision-making, planning, and strategy formulation. In the advent of technological advancement, the role of managerial accounting professionals has expanded immensely due to the radical changes in the business environment. Technological advancement has increased competition in the industry giving managerial accounting professionals the challenging task of analyzing massive information that aid management in decision-making.

Although managerial accounting is not subject to any standards during computation of reports, most international firms use professionals with Certification in Management Accounting (CMA) to carry out managerial accounting functions. Effective managerial accountants should be able to carry the responsibility of analyzing massive and critical information, thus enabling smooth decision making and planning in the organization. The course provides accountants with the ability to evaluate financial and economic information and analyze patterns in the business environment using modeling and information systems. In addition, the course equips accountants with the ability to analyze decisions and generation of reports for internal and external use.

Absorption costing method uses functions such as sales, cost of sales, administrative, distribution, marketing, and financial expenses to classify costs. On the other hand, contribution costing classifies costs depending on their behavior, that is, as fixed and variable. Variable costs vary with level of production while fixed cost remains constant over a period. The two methods vary in principle such that, absorption-costing method uses cost of goods as an intermediate step, while contribution-costing method uses product contribution. In addition, absorption costing allocates fixed production overheads to the individual product units making it easy to ascertain the profit made by each product even in the long term. Organizations do not always sell goods in the period of production; thus, the selling price and profit of a product vary with time of sale. This makes it particularly beneficial to apportion all costs incurred in the production of the goods and services in the period of production to make it easy to determine its profitability in the future. Contribution costing treats fixed production overheads as period costs.

Income in absorption and contribution costing differ when the closing and opening inventory figures are not the same. The two methods differ in their treatment of fixed production overheads. Contribution costing charges fixed production overheads as period costs (Walther, 2011, p.85). The method deducts fixed manufacturing overheads from profits made in a period. On the other hand, absorption-costing charges fixed manufacturing overheads to the cost of goods. This method distributes fixed production overheads to all goods produced, which ensures that closing stock and work in progress figures contain the fixed production overheads.

Different costing methods produce varying income due to the difference in treatment of accounting items. This may lead to overstatement or understatement of profits. To ensure comparability across the industry, companies should follow Generally Accepted Accounting Principles (GAAP’s) when accounting for items in the income statement. Companies using the absorption or contribution costing methods should prepare an alternative income statement for external purposes following the GAAP’s. Income statements following GAAP’s enhance uniformity thus allowing comparability across the industry.

The alternative income statement enables the organization to evaluate its performance in relation to its competitors in the industry. After establishing its position in the industry, management of the company should then adopt and implement strategies that will lead to improvement of its performance. In addition, the alternative income statement helps organization to set performance standards by setting benchmarks against the best company in the industry. The alternative income statement gives organizations an opportunity to create strategic alliances with outside users of financial information such as lenders and creditors.

Break even analysis is a tool used by management to establish the relationship between volume, cost, and profits. Break-even analysis helps a company to establish technology, strategy, and policies to employ in a bid to attain profitability. According to Edwards, Hermanson, and Invacevich (2007), breakeven analysis helps management to establish the volume of a product to manufacture in order to attain profitability (p.73). The break-even point is the point where costs of production are equal to the revenue from the sale. By establishing the break-even point, management will ascertain the volume above which the company is making profits. For example, if the fixed cost is $5000, the company should ensure the sales revenue is above $5000 in order to make profits. In addition, the break-even analysis helps to identify the product mix, which is profitable, thus establishing which products to manufacture; for example, an organization should combine products that use the same technology and processes in order to reduce fixed cost.


Accounting for Management. (2011). Managerial or Management or Cost Accounting Terms and Definitions. Web.

Edwards, D., Hermanson, H., & Invacevich, S.D. (2007). Accounting Principles: A Business Perspective. Managerial Accounting, 2, 73-87.

Introduction to Managerial Accounting (2007). Web.

Martin, J. R. (2011). Management Accounting: Concepts, Techniques, and Controversial Issues: Introduction to Managerial Accounting, Cost Accounting, and Cost Management Systems. Web.

Walther, L. M. (2011). Financial Accounting: Principles of Accounting. USA: CreateSpace.

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