Scribd Logo
Upload

Welcome to Scribd!

  • 6 views

    2019 CIA P3 SIV 2B 4 Variable and Absorption Costing

    Uploaded by

    MarieJoia
    Variable and absorption costing are two costing methods that differ in their treatment of fixed manufacturing overhead costs and presentation of costs. Under variable costing, fixed overhead costs are expensed as incurred, while under absorption costing they are allocated to production units. Absorption costing breaks costs into manufacturing and non-manufacturing, while variable costing breaks them into variable and fixed.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd

    2019 CIA P3 SIV 2B 4 Variable and Absorption Costing

    Uploaded by

    MarieJoia
    6 views18 pages
    Variable and absorption costing are two costing methods that differ in their treatment of fixed manufacturing overhead costs and presentation of costs. Under variable costing, fixed overhead costs are expensed as incurred, while under absorption costing they are allocated to production units. Absorption costing breaks costs into manufacturing and non-manufacturing, while variable costing breaks them into variable and fixed.

    Copyright

    © © All Rights Reserved

    Available Formats

    PPTX, PDF, TXT or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    Variable and absorption costing are two costing methods that differ in their treatment of fixed manufacturing overhead costs and presentation of costs. Under variable costing, fixed overhead costs are expensed as incurred, while under absorption costing they are allocated to production units. Absorption costing breaks costs into manufacturing and non-manufacturing, while variable costing breaks them into variable and fixed.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    6 views18 pages

    2019 CIA P3 SIV 2B 4 Variable and Absorption Costing

    Uploaded by

    MarieJoia
    Variable and absorption costing are two costing methods that differ in their treatment of fixed manufacturing overhead costs and presentation of costs. Under variable costing, fixed overhead costs are expensed as incurred, while under absorption costing they are allocated to production units. Absorption costing breaks costs into manufacturing and non-manufacturing, while variable costing breaks them into variable and fixed.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    You are on page 1of 18

    Variable and Absorption

    Costing
    How They are Different
    Variable and absorption costing are two
    methods of costing that are different in
    only two ways:
    1. The treatment of fixed manufacturing
    overhead (such as factory rent), and
    2. The presentation on the statement of
    profit or loss of different costs.
    1. Treatment of Fixed Factory
    Costs
    Under variable costing, fixed factory
    overheads are treated as a period cost
    and are expensed as they are incurred.

    Under absorption costing, fixed factory


    overheads are allocated to the units
    that were produced during the period.
    Absorption Predetermined Rate

    Budgeted Monetary Amount of Fixed


    Manufacturing Overhead
    Budgeted Activity Level of Allocation Base
    Variable
    Fixed
    Factory
    Overhead
    Variable
    Fixed
    Factory
    Overhead
    Income
    Statement
    Variable Absorption
    Fixed Fixed
    Factory Factory
    Overhead Overhead
    Income
    Statement
    Variable Absorption
    Fixed Fixed
    Factory Factory
    Overhead Overhead
    Income Balance
    Statement Sheet
    Variable Absorption
    Fixed Fixed
    Factory Factory
    Overhead Overhead
    Income Balance
    Statement Sheet

    Income
    Statement
    Variable Absorption
    Fixed Fixed
    Factory Factory
    Overhead Overhead
    Income Balance
    Statement Sheet
    Year
    End Income
    Statement
    Example: Fixed overhead is applied to units produced on the
    basis of direct labor hours. The standard number of direct labor
    hours allowed per unit produced is 0.5 hours. The company
    budgets 1,500,000 in fixed overhead costs for the year and
    budgets to produce 750,000 units.
    Since 0.5 hours of direct labor are allowed per unit produced, the
    standard number of direct labor hours allowed for the budgeted
    number of units is 750,000 × 0.5, or 375,000 DLH. The fixed
    overhead application rate is therefore 1,500,000 ÷ 375,000, or
    4.00 per DLH.
    The company actually produces 800,000 units, incurring 1,490,000
    in actual fixed factory overhead. The amount of fixed overhead
    applied to the units produced is 4.00 × (800,000 × 0.5), which
    equals 1,600,000. Fixed factory overhead is over-applied by
    110,000 (1,600,000 applied − 1,490,000 actual incurred cost).
    Note that the fixed factory overhead incurred did not increase
    because a greater number of units was produced than had
    been planned. In fact, fixed overhead incurred was actually lower
    than the budgeted amount. That can occur because fixed factory
    overhead does not change in total because of changes in the
    activity level, as long as the activity level remains within the
    relevant range.
    In contrast, variable factory overhead, which is applied to
    production in the same way as fixed factory overhead, does
    change in total because of changes in the activity level.
    Effect of Changing Inventory Levels
    When inventory increases (production >
    sales), absorption provides a higher
    net income.

    When inventory decreases during the


    period (production < sales), absorption
    provides a lower net income.
    2. Presentation
    Classification of costs is different under the
    two methods.
    • Absorption breaks down costs as
    manufacturing and nonmanufacturing.
    • Variable breaks the costs down as
    variable and fixed.
    Absorption Costing Presentation
    Sales revenue
    − COGS (incl. variable and fixed mfg. costs)
    = Gross margin
    − Variable non-manufacturing costs (expensed)
    − Fixed non-manufacturing costs (expensed)
    = Income from operations
    Variable Costing Presentation
    Sales revenue
    − Variable manufacturing costs
    = Manufacturing contribution margin
    − Variable non-manufacturing costs (expensed)
    = Contribution margin
    − All fixed manufacturing costs (expensed)
    - All fixed non-manufacturing costs (expensed)
    = Income from operations
    Variable / Absorption Comparison
    Though absorption costing is required by US GAAP,
    variable costing is generally considered to be better for
    decision making by management because:
    • Fixed costs are usually not relevant in decision making.
    • Operating income is influenced by the level of sales only
    and not by changes in inventory levels.
    • Variance analysis under absorption costing is difficult.
    • The impact on income of fixed costs is visible under
    variable costing.
    • It is easier to calculate contribution for a division or
    product when variable costing is used.

    You might also like