The two most common methods used by manufacturing companies to cost inventories are variable costing and absorption costing. We describe each of the methods in this section and then discuss them in detail, using a hypothetical telescope-manufacturing company as an example.
Variable costing is a method of inventory costing in which all variable manufacturing costs (direct and indirect) are included in inventoriable costs. All fixed manufacturing costs are excluded from inventoriable costs and are instead treated as costs of the period in which they are incurred. Note that variable costing is an imprecise term in the sense that only variable manufacturing costs are inventoried; variable nonmanufacturing costs are still treated as period costs and are expensed. Another commonly used term to describe this method is direct costing. This term is also imprecise because variable manufacturing overhead (an indirect cost) is considered inventoriable under variable costing, whereas fixed direct costs, such as marketing costs, are considered period costs.