Which of the following is normally included in product cost under the variable costing method?
A) Prime cost and all conversion cost.
B) Direct materials cost, direct labour cost, but not manufacturing overhead cost.
C) Direct materials cost, direct labour cost, and variable manufacturing overhead cost.
D) Prime cost but not conversion cost.
The correct answer and explanation is :
The correct answer is:
C) Direct materials cost, direct labor cost, and variable manufacturing overhead cost.
Explanation:
The variable costing method is an approach used in managerial accounting where only variable production costs are included in the product cost. Fixed manufacturing overhead costs are treated as period costs and expensed in the period they are incurred.
Under variable costing, product cost includes:
- Direct materials (DM): The raw materials used in the production process.
- Direct labor (DL): The wages paid to workers directly involved in manufacturing the product.
- Variable manufacturing overhead (VMOH): Costs that vary with production levels, such as indirect materials, utilities, and factory supplies.
What is excluded?
- Fixed manufacturing overhead (FMOH): Costs such as rent, depreciation, and salaries of factory supervisors are considered period costs and not included in product cost.
Why is this important?
- Decision-Making: Variable costing helps managers make short-term decisions by focusing only on costs that change with production levels.
- Contribution Margin Analysis: It allows businesses to analyze profitability by highlighting how much revenue contributes to covering fixed costs.
- Cost-Volume-Profit (CVP) Analysis: This method helps in understanding how costs behave at different levels of production.
Why Other Options Are Incorrect:
- Option A: Includes all conversion costs (direct labor + manufacturing overhead), which is incorrect since fixed overhead is excluded.
- Option B: Excludes variable manufacturing overhead, which should be included.
- Option D: Includes only prime costs (direct materials + direct labor) and ignores variable overhead.
Thus, the correct choice is C as it aligns with the principles of variable costing.
