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    Absorption and Variable Costing

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    Christopher Price
    Absorption costing and variable costing are two methods for calculating product costs and net income. Absorption costing includes all manufacturing costs, including fixed overhead, as product costs. Variable costing only includes variable manufacturing costs as product costs and treats fixed costs as period costs. Under absorption costing, net income is influenced by production levels due to inventory valuations, while variable costing net income depends on sales volume. Differences in inventory levels between the two methods can cause net income to vary.

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    Absorption and Variable Costing

    Uploaded by

    Christopher Price
    295 views4 pages
    Absorption costing and variable costing are two methods for calculating product costs and net income. Absorption costing includes all manufacturing costs, including fixed overhead, as product costs. Variable costing only includes variable manufacturing costs as product costs and treats fixed costs as period costs. Under absorption costing, net income is influenced by production levels due to inventory valuations, while variable costing net income depends on sales volume. Differences in inventory levels between the two methods can cause net income to vary.

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    Absorption costing and variable costing are two methods for calculating product costs and net income. Absorption costing includes all manufacturing costs, including fixed overhead, as product costs. Variable costing only includes variable manufacturing costs as product costs and treats fixed costs as period costs. Under absorption costing, net income is influenced by production levels due to inventory valuations, while variable costing net income depends on sales volume. Differences in inventory levels between the two methods can cause net income to vary.

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    © All Rights Reserved
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    Download as docx, pdf, or txt
    295 views4 pages

    Absorption and Variable Costing

    Uploaded by

    Christopher Price
    Absorption costing and variable costing are two methods for calculating product costs and net income. Absorption costing includes all manufacturing costs, including fixed overhead, as product costs. Variable costing only includes variable manufacturing costs as product costs and treats fixed costs as period costs. Under absorption costing, net income is influenced by production levels due to inventory valuations, while variable costing net income depends on sales volume. Differences in inventory levels between the two methods can cause net income to vary.

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    Absorption costing and variable costing are two different costing methods. Absorption costing allocates both fixed and variable costs to inventory, while variable costing only allocates variable costs to inventory. Fixed costs are expensed as period costs under variable costing.

    Absorption costing allocates both fixed and variable manufacturing costs to inventory as product costs. Variable costing only allocates variable manufacturing costs to inventory as product costs and treats fixed manufacturing costs as period costs.

    Fixed manufacturing costs are classified as indirect product costs under absorption costing.

    MAS-06: Absorption and Variable Costing

    ABSORPTION COSTING
    Also known as
    Users
    Presentation/ Format

    Classification of cost
    Inventoriable cost/ product cost/
    unit cost

    Period cost

    Full Costing
    External

    VARIABLE COSTING
    Direct Costing
    Internal

    Sales

    xxx

    Sales

    xxx

    Cost of sales

    (xx)

    Variable Cost

    (xx)

    Gross profit

    xx

    Expense

    (xx)

    Net profit

    xx

    Not required
    All product cost

    xx

    Fixed Cost

    (xx)

    Net profit

    xx

    Required
    All variable manufacturing cost

    Direct material
    Direct labor
    Variable factory overhead
    Fixed factory overhead

    Selling and Administrative Expense

    Contribution Margin

    Selling and Administrative Expense

    Variable
    Fixed

    Direct material
    Direct labor
    Variable factory overhead

    Variable
    Fixed

    Fixed factory overhead


    Fixed factory overhead (FFOH)
    Net profit is influenced by:
    In accordance with accounting
    principles

    expensed when the product is sold


    Production
    Yes

    Expensed in the period incurred


    Sales volume
    No

    Matching principle

    Note:

    1.
    2.
    3.
    4.
    5.

    The amount of inventories under absorption costing is always higher than the inventories
    under variable costing.
    If production is equal to sale, then absorption costing income is expected to be equal to the
    variable costing income.
    If production is greater than sales, then income under absorption costing is higher than the
    variable costing.
    If sales is greater than production, then income under variable costing is higher than the
    absorption costing
    Reconciliation of income:

    income = inventory x
    FFOH per unit
    Income - absorption costing

    xxx

    Add: FFOH in beginning inventory

    xxx

    Total

    xxx

    Less: FFOH in ending inventory


    Income - variable costing

    xxx
    P

    xxx

    Exercise 1:

    The company operated at a normal capacity of 10,000 units in the year 2014. The company sold
    80% of these units at a price of P12 per unit. Manufacturing costs incurred during the year are as
    follows:
    Manufacturing:
    Materials
    Labor
    Variable Factory
    Overhead
    Page 1 of 4

    P
    10,000
    15,000
    5,000

    Fixed Factory Overhead


    Selling and administrative
    Variable
    Fixed

    REQUIREMENTS: Determine the following:


    1.
    2.

    Inventory cost per unit under absorption and variable costing.


    Cost of ending inventory under absorption and variable costing.

    Page 2 of 4

    20,000
    P15,000
    8,00
    0

    Exercise 2:
    ABC Company sells its product for P2,000 each. Data for the current years operations are as follows.
    Units:
    Beginning Inventory
    10
    Production
    80
    Ending Inventory
    20
    Variable Costs:
    Direct Materials
    Direct Labor
    Factory Overhead
    Selling and
    Administrative
    Fixed Costs:
    Factory Overhead
    Selling and
    Administrative

    P24,00
    0
    16,00
    0
    8,00
    0
    4,00
    0
    P20,00
    0
    2,0
    00

    REQUIRED:
    1.
    Prepare income statements under both absorption and variable costing.
    2.
    Provide computations explaining the differences in income between the two costing methods.
    Multiple Choices:
    1.
    Using absorption costing, fixed manufacturing costs are best describe as:
    a. Direct period costs
    c. Direct product costs
    b. Indirect period costs
    d. Indirect product costs
    2.

    If production is higher than sales then absorption costing income is expected to


    a. Higher than variable costing income
    c. Lower than the variable costing income
    b. Equal to the variable costing income
    d. Erratic under variable costing

    a.
    b.
    c.
    d.

    P
    P
    P
    P

    3. Black Company produced 10,000 units and sold 9,000 units. Fixed manufacturing overhead costs
    were P 20,000, and variable manufacturing overhead costs were P 3 per unit. For the period, one
    would expect net income under the absorption costing method to be
    2,000 more than net income under variable costing method
    5,000 more than net income under variable costing method
    2,000 less than net income under variable costing method
    5,000 less than net income under variable costing method

    4. Green Company has operating income of P 50,000 using direct costing for a given period. Beginning
    and ending inventories for that period were 13,000 units and 18,000 units, respectively. If the fixed
    factory overhead application is P 2 per unit, the operating income using the absorption costing is:
    a. P 40,000
    b. P 50,000
    c. P 60,000
    d. P 70,00
    5. Violet Company had 16,000 units in the beginning inventory. During the year, the companys
    variable production costs were P6 per unit and its fixed manufacturing overhead costs were P 4 per
    unit. The companys net income for the year was P 24,000 lower under absorption costing than it
    was under variable costing. Given these facts, the number of units in the ending inventory must
    have been
    a. 22,000 units
    b. 10,000 units
    c. 6,000 units
    d. 4,000 units

    a.
    b.
    7.

    8.

    6. Pink Co. had a net income of P 85,500 using variable costing and net income of P 90,000 using
    absorption costing. Total fixed manufacturing overhead cost was P 150,000, and production was
    100,000 units. Between the beginning at the end of the year, the inventory model
    Increased by 4,500 units
    c. Increased by 3,000 units
    Decreased by 4,500 units
    d. Decreased by 3,000 units

    Variable costing is unacceptable for


    a. Cost-volume-profit analysis
    b. Financial Reporting

    c. Transfer pricing
    d. Short-term decision making

    How many statement(s) is/are true?


    a. Variable costing income fluctuates with production and does not react to changes in sales
    b. Variable costing violates matching principle
    c. Under variable costing, all variable expenses are treated as product costs.
    d. Under a just-in-time (JIT) production environment, income under absorption costing tends to be
    equal with income under variable costing.

    Page 3 of 4

    a. one

    b. two

    c. three

    d. four

    9. White Co. manufacturers a single product. Unit variable production costs are P 20 and fixed
    production costs are P 150,000. White uses normal activity of 10,000 units. White began the
    year with no inventory, produced 12,000 units, and sold 7,500 units.
    A.) Determine the product cost under variable costing
    a. P 20.00
    b. P 32.50
    c. P 35.00
    B.) Determine the product cost under absorption costing

    d. P 40.00

    a. P 20.00
    b. P 32.50
    c. P 35.00
    C.) Determine the capacity or volume variance under absorption costing

    d. P 40.00

    a. P 24,000 unfavorable

    d. P 30,000 favorable

    P 24,000 favorable

    c. P 30,000 unfavorable

    Page 4 of 4

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