Valuation Of Finished Goods Inventory Under Variable Costing And Absorption Costing

Since inventory is an asset, the difference in the value of inventory changes the size of income and the size of assets in a balance sheet. Income statement and balance sheet both are affected by the value of inventory. That is why we get different income and assets under these two costing methods. Inventoriable costs are product costs, which differ under the two costing system as under.

Inventory value under variable costing
= Direct material+ Direct labor+Variable manufacturing costs

Inventory value under absorption costing
= Direct material+Direct labor+variable manufacturing costs+Fixed manufacturing costs

Finished goods inventories are over-stated in absorption costing as it includes one more cost element in inventory value than under variable costing, i.e the fixed manufacturing cost.