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Variable and absorption costing is a method of inventory valuation that is used by companies to determine the cost of an item or unit produced as part of their manufacturing process The primary difference between variable and absorption costing is that variable costing allocates only variable manufacturing costs to each item produced, while absorption costing also allocates fixed manufacturing costs. The goal of variable and absorption costing is to accurately measure the financial performance of a company's manufacturing process, which is essential for good decision-making. Variable costing is a method of inventory valuation in which only variable costs are allocated to each unit produced. Variable costs are those costs that vary with the number of items produced and typically include direct labor, raw materials, and commissions paid to salespeople. Variable costing is simple and straightforward and does not require any calculations or estimates of overhead. This approach better reflects the true costs of producing each item, as only the costs to produce the item are included in the cost of the item. Absorption costing is a method of inventory valuation in which both variable and fixed costs are allocated to each item produced. Fixed costs are those costs that remain constant regardless of the number of items produced, and typically include indirect costs such as rent, energy, and insurance. Absorption costing provides more accurate cost information as it takes into account the cost of producing the item in its entirety, but it is generally more complicated because it requires calculating the estimated overhead associated with producing each item. The following are the best five examples of variable and absorption costing in action. 1. A company that produces custom furniture is using variable costing to assign costs to each item produced. The company only includes direct labor and material costs in the cost of the furniture, as these costs vary with the number of items produced. 2. A restaurant uses absorption costing to assign costs to each dish served. The restaurant includes both the cost of ingredients and the rent, energy, and other fixed costs in the cost of each dish, as these costs all contribute to the cost of producing the dish. 3. A company that produces computer tablets is using variable costing to assign costs to each tablet produced. The company only includes direct labor, materials, and commissions paid to salespeople in the cost of the tablet, as these costs vary with the number of tablets produced. 4. An apparel retailer uses absorption costing to assign costs to each item of clothing sold. The retailer includes both the cost of the fabric and the rent, energy, and other fixed costs in the cost of each item of clothing, as these costs all contribute to the cost of producing the clothing. 5. A software company is using variable costing to assign costs to each software license sold. The company only includes direct labor and material costs in the cost of the software license, as these costs vary with the number of licenses sold.