Absorption costing:

A costing method that includes all manufacturing costs, direct materials, direct labor and both variable and fixed overhead as part of the cost of a finished unit of production.
For example in this method the unit cost is as follows:

Unit cost           
Direct material:           03
Direct labor:               02
Variable MOH:          03
Fixed MOH:               02                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
Total                   $ 10 per unit
Here fixed and variable MOH both are considered.

Role in decision-making

Absorption costing is the generally accepted method for preparing mandatory external financial reports and income tax returns. Absorption costing treats fixed manufacturing overhead as a product cost. If fixed costs are treated as period costs and there is a low level of sales activity in a period then a low profit or a loss will be recorded. If there is a high level of sales activity there will be relatively high profit. Absorption costing creates a smoothing of these fluctuations by carrying the fixed costs forward until the goods are sold. Many firms use the Absorption approach exclusively because of its focus on full costing of units of product.

Variable costing:

In variable costing, only variable costs of production are allocated to products and the unsold stock is valued at variable cost of production. Fixed production costs are treated as a cost of the period in which they are incurred.
For example in this method the unit cost is as follows:

Unit cost           
Direct material:          03
Direct labor:               02
Variable MOH:          03
Total                   $ 08 per unit

Here fixed MOH is not considered.

Role in decision-making

Variable costing is used internally for planning purposes. Under Variable costing, only those production costs that vary with output are treated as product cost. This includes direct material, direct labor and variable overhead. Fixed manufacture overhead is treated as a period cost and charged off against revenue as it is incurred, the same as selling and administrative expenses. Under Variable costing, the profit for a period is not affected by changes in inventory. This cost is particularly important for company having cash flow problems. One thing is very important that when Variable costing is in use profits move in the same direction as sales. We can also take the data for CVP analysis directly from a contribution margin format income statement that are not available on a conventional income statement based on absorption costing. The Variable costing approaches are often indispensable in profit planning and decision-making.