The variable costing system is widely used for internal management purposes rather than for external reporting. It is more useful for taking managerial decision making. As such the variable costing system is useful for:
1. Profit Planning
It is a technique of preparing and using an operational plan for the objective of achieving the profit target. It gives focus on the contribution margin which facilitates for understanding the inter-relationship between cost, volume and profit.
Variable costing helps in determining the break-even sales as well as sales level at which the firm will able to attain the target profit. Variable costing also helps in evaluating the impact of changes in volume, variable and fixed cost and product mix on profit. The contribution margin makes it comfortable in selecting the most profitable product, territories and customers.
2. Cost Control
The major tool for controlling the costs are standard costing and flexible budget. This costing system segregates the costs into fixed and variable for the purpose of controlling the cost. So, the attention is given to the fixed cost which is treated as the period cost and deducted from the contribution margin to get profit.
3. Decision Making
The cost associated with the product plays a key role in decision making. Variable costing identifies and classify costs into fixed and variable cost and provide valuable information for making decisions. Fixed costs, generally, create problem in making decision because of difficulties in their allocation. Under variable costing, they are assumed to remain constant and are not considered relevant in decision making. The fixed costs are treated as period costs and contribution margin above the fixed cost is the profit. In a decision involving alternative choices, alternative one with the highest contribution margin is selected. The decision areas where variable costing is particularly useful and relevant are pricing decisions, make or buy decision, product mix decision etc.
4. Pricing Decision
Variable costing helps the management for fixation of price, volume or sales mix as variable costing clearly identifies the reasons of fluctuation in profit is due to fluctuation in sales rather than of production. Moreover, it is also helpful in evaluating the performance of various departments of the firms which generates the revenues.
