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~:~AGEMENT ADVISORY SERVICES

2605 VARIABLE & ABSORPTION COSTING
CPA REVIEW BOBADlllA/U RO/TRJNJDAO
MAY 2019
LfCTURf! NOTl:S

l. ~ha r~able costing treat s on ly th ose costs of producti on
d' a tvary with output as product co5ts. Ord lnarlly,
,rec rnaterla ls, direct labor and va riable
manufacturing overhead costs wou ld be Included In
product costs under variable costing . Fixed
manufacturing overhead Is not treated as a period
cost and I:;; charged off aga inst revenue each period.
2 • Absorption costing treats .all costs of producti on as
product costs, regardless of whethe r they are
variable or fixed in nature . Under the absorption
costing .method , a portion of fixed manufacturing
overhead Is allocated to each un it of product.
Comparison of Absorption and Variable Costing.
When comparing absorption cost ing and variab le
costing Income statements, a number of points
should be noted :
1. Deferral of fixed manufacturing costs under
absorption costing. Under the absorpti on costing
method , i1' inventories increase then a porti on of the
fixed manufacturing overhead costs of the current
period is deferred to future periods through the
inventory account. When the units are later taken
out of Inventory and sold, the deferred fixed costs
flow through to the income statement .
2. Differences in Inventories under the two
methods. The ending inventory figures under the
variable costing and absorption costing methods are
different . Under variable costing, only the variable
manufacturing costs are included in Inventory. Under
absorption costing, both variable and fixed
· manufacturing costs are included in inventory .
Suitability for CVP analysis. The absorption costing
income statement is not well su ited for provid ing
data for CVP computations since It makes no
distinction between fixed and variable costs . In
contrast, the variable costing method classifies costs
by behavior and is very useful in setting -up CVP
computations .
Extended Comparison of Income Data.
1. Production equals sales (no change In inventories) .
When production equals sales, there is no change in
inventories . If there is no change in inventories, 4. Fixed costs are more visible . The impact of fixed
then there is no change in the fixed manufacturing
overhead costs in inventories under absorption
costing .
2. Production exceeds sales (inventories increase) .
When production exceeds sales, inventories grow . If
inventories grow, then some of the current fixed
manufacturing overhead costs will be deferred in
inventories under absorption costing. Since all of the
current fixed manufacturing overhead costs are
expensed under variable costing, the net income
reported 1Jnder absorption costing will be greater
than the net income reported under variable costing .
3. Sales exceeds production (inventories decrease).
When salEis exceeds production, inventories shrink .
If inventeirles .. decrease; then some of the fixed
manufacturing overhead costs that had been
deferred in Inventories In previous periods will be
released to _the income statement as a charge
against income as well as all of the current fixed
rrlll nuracturlng overh ead costs . Si nce only th e
current fixed manufacturing overhead costs are
ex pensed unde r variable costi ng, the net income
reported unde r absorption costing will be less than
the net Income reported under variable cost ing .
4 . Long-term differences in income . Over an extended
period of tim e, t he cumu l a t i ·✓ c net lnccr.i e ~i~ures
reported under absorption costing and va r1able
costing will be about the same ; they will differ on ly
by the amount of fixed manufacturing overhead cost
in end ing Inventories unde r absorption costing .
Cumu lative net Income figures will be identica l
wheneve r ending Inventories are reduced to zero .
5. Changes In production volume. Variable costing net
income Is not affected by changes in production
vol ume . Absorption costing net income Is affected by
changes in production volume . For any given level of
sa les, net Income under absorption costing will
increase as the level of output increases and hence
inventories increase .
Advantages of the ContrlbutitJr, ~rpr~a<:h . Thi> r':! ere
a number of advantages to using variable costing (and
the contribution approach) in interna l reports and
analysis.
1. More usefu l fo r CVP ana lysis. Variable costing
statements provide data that are immediately usefu l
fo r CVP analysis since they categorize costs on the
basis of the ir behavior.
2. Income is not affected by changes in production
volume . Under absorption costing , reported net
income is affected by changes in production since
fixed costs are spread across more or fewer units .
This can distort income and may even result in
income moving in an opposite directi on from sales .
Thi~ does not occur under varial51e costing .
3. Avoids misunderstandings concern ing unit product
costs . Absorption costing un it product costs can be
easily misinterpreted as variable costs since they are
stated on a per unit basis. Such a misperception can
lead to serious errors in making decisions. Variable
costing avoids th is problem since un it costs include
only variab le costs.
costs on profits is emphasized because the tota l
amount of such costs fo r the period appears
separately and is high lighted in the income
statement rather than being buried in cost of goods
sold and ending inventory.
5. Understandability. Managers may find it easier to
understand variable costing reports because data
are organized by behavior and because variable
costing is much closer to a cash flow concept.
6. Control is facilitated . Variable costing ties in with
cost control methods such as flexible budgets.
7. Incremental analysis is more straight-forward .
Variable cost corresponds closely with the current
out-of-pocket expend iture necessary to produce and
sell products and services and can therefore be used
more readily in incremental analysis than absorption
costing data. And since variable costing net income
is closer to net cash flow than absorption costing net

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EXCEL PROFESSIONAL SERVICES, INC.
income, it is likely to be more useful to compan ies
that have cash flow problems.
Problem 1 . Hanky Company produced 30,000 un its
curi ng its first year of operations and sold 26,000 at PS0
per unit. The company chose pract ical activity at 30 ,000
units to compute its predetermined overhead rate .
Manufacturing costs are as follows :
Direct materials P420,000
Direct labor 240,000
Expected and actual variable overhead 90,000
Expected and actual fixed overhead 300,000
Variable selling and admin istrative costs 130,000
Fixed sell ing and administrative costs 100,000
Required :
1. Calculate the cost of fin ished goods inventory under
variable costing.
2. Calculate the cost of finished goods inventory under
absorption costing .
3. Prepare two income statements, first, using
contribution margin format and second, absorpt ion
costing .
Problem 2 . J: nformation taken from annual budget of
Malta Corporation follows .
Direct materials used P320,000
Direct labor 120,000
Variable factory overhead 80 ,000
Fixed factory overhead 200,000
Variable sell ing & adm costs 60,000
Fixed selling & adm costs · 90,000
Sales revenue 1, 120,000
Requ ired :
1. Assuming the use of variable costing, compute the
inventoriable costs for the year.
2. Compute the month 's inventoriable costs using
absorption costing.
3. Without preparing income statements, calculate the
difference in profit between variable costing &
absorption costing ·assuming :
a) Production, 40,000 units ; sales, 36,000
b) Production, 40,000 units; sales , 42,000
MULTIPLE CHOICE
l. If a firm produces more units than It sells,
absorption costing, relative to variable costing , will
result in
a. higher income and assets
b. lower income but lower assets
c. higher income but lower assets
d. lower income and assets
2. Under absorption costing, if sales remain constant
from period 1 to period 2, the company will report a
larger income in period 2 when
a. period 2 production exceeds period 1 production
b. period 1 production exceeds period 2 production
c. variable production costs are larger in period 2
thart period 1
d. fixed production costs are larger in period 2 than
period 1
3. The variable costing format is often more useful to
managers than the absorption costing format
because
a. costs are classified by their behavior
b. it is required for external reporting
costs are always lower
it justifies higher product prices
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Illustrative Exercises
4 . When a firm prepares financial reports using
absorpt ion costing
a. profits will always increase with increase in sales
b. profits will always decrease with decreases in
sales
c. profits may decrease with increased sales even if
there is no change in selling prices and costs
d. decreased outrut and ronst;,nt ~;ilP.s rec;11ir in
in creased profits
5. Wh ich of the following statements is true for a firm
that Absorption cost ing?
a. expenses marketing costs as cost of goods sold
b. treats direct manufacturing costs as a period
cost
c. includes fixed manufacturing overhead as an
inventoriable cost
d. is required for Internal reports to managers
· 6. Which of the following is true about variable costing?
a. The cost of a unit of product changes because of
changes in the number of units manufactured
b. Profits fluctuate with sales
c. An idle facility variation is calculated
d. None of the given choices
7. Advocates of variable costing argue that :
a. fixed production costs should be added to
inventory because such costs have future service
potential and therefore are inventoriable as an
asset.
b. fixed production costs should be capitalized as
an asset and amortized over future periods when
benefits from such costs are expected to be
received .
c. fixed production costs should be charged to the
period in which they are incurred unless sales de
not equal production in which case any
differ~nce should be capitalized as an asset and
amortized over future periods.
d. fixed production costs should be charged to the
period in wh ich they are incurred.
8. In an income statement prepared as an internal
report using variable costing, variable sell ing and
administrative expenses would :
a. not be used.
b. be used in the computation of the contribution
margin .
c. be used in the computation of net operating
income but not in the computation of the
contribution margin .
d. be treated the same as fixed selling and
administrative expenses .
9 . Under variable costing :
a. net operating iiK0rne wiii tend i.o rnove up a11ti
down in response to changes in levels of
production .
b. inventory costs will be lower than under
absorption costing .
c. net operating income will tend to vary inverselv
with production changes .
d. net operating income will always be higher than
under absorption costing .
10 . In an income statement prepared using the variable
costing · method , fixed selling and administrative
expenses would :
a. be used in the computation of the contribution
margin .
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b. be used In the com t Problem 4 . Tribal Company has per-unit fixed and
Income but not In pu atlon of net operating
th variable manufacturing costs of P12 and P4 ,
contribution margin . e computation of tl1e
respectlvely . Varlable selling c>f'ld 11dl'flln1st rilti •1 P.
c. be treated the same , costs are pg per unit and fixed selling and
as variable manufacturing
expenses . adm inistrative expenses are P90,000 . Consider the
d. not be used . two Independent cases · that follow for the firm .

11 . Which of the following is true of a company that , case A: Varlable -costlng net income, P60,000 ; sales,
uses absorption costing? 25 ,000 units ; production , 30 ,000 units
a. Net operat'ing ·income fluctuates directly with case a: variable -costing net Income , PB0, 000 ; sales ,
changes in sales volume . 27,500 units ; production, 25,000 units
b. Flxe~ production and fixed selling costs are
considered to be product costs . Required :
c. Unit pro~uct costs can change as a result of 1. From a product-costing perspective, what is the
cha~ges in the number of units manufactured . basic difference between absorption costing and
d. Variable selling expenses are included in product variable cost ing?
costs . 2. compute Tribal's absorption -costing net income
in Case A.
12 - Under absorption costing, fixed manufacturing 3. compute Tribal's absorption -costinQ net income
overhead costs : in Case B.
a. are deferred in inventory when production
exceeds sales . Problem s. During its first year of operations,
b. are always treated as period costs . Snobegon , Inc., (located in ~ake Snobegon ,
c. are released from inventory when production Minnesota) produced 27,000 plastic snow scoops.
exceeds sales . Snow scoops are oversized shovel-types scoops that
d. none of these. are used to push snow away. Unit sales were 26,400
scoops . Fixed overhead was applied at PO . 75 per
13 . _ _ _ _ method(s) expense(s) variable unit produced . Fixed overhead was underapplled by
marketing co.sts in the period incurred. P3,000 . This fixed overhead variance was closed to
a. Variable costing Cost of Goods Sold. There was no variable overhead
b. Absorption costing variance . The results of the year's operations are as
c. Throughput costing follows (on an absorption-costing basis) :
d. All of t hese answers are correct .
Sales (26,400 units @ P12) P316,800
Less: Cost of good sold 161.400
14 . The contribution-margin format of the income
Gross margin PlSS,400
statement :
a. is used with absorption costing Less : Selling and administrative
expenses (all fixed) 120,000
b. highlights the lump sum of fixed manufacturing
Operating income P 35 400
costs
c. distinguishes manufacturing costs from
nonmanufacturing costs Required:
d. calculates gross margin 1. Give the cost of the firm 's ending inventory under
absorption costing . What is the cost of the end ing
15. The gross-margin format of the income statement : inventory under variable costing?
a. distinguishes between manufacturing and 2. Prepare a variable-costing wincome statement.
nonmanufacturing costs Reconcile the difference between the two income
b. distinguishes variable costs from fixed costs figures.
c. is used with variable costing
d. calculates contribution margin Problem 6 . Rome Company began operations 011
January 1 to produce a fishing rods . It uses a
Problem 3. Relevant Corporation has fixed standard absorption costing system with a planned
manufacturing cost of PB per unit . Consider the production volume of 100,000 units. 'During its first
three independent cases that follow. year of operations, no variances were incurred and
there were no fixed selling or administrative
Case A: Absorption- and variable costing net income expenses. Inventory on December 31 was 20 000
each totaled P160,000 in a period when the firm units, and net income for the year was P480,000'.
produces 20,000 units .
Case 8 : Absorption-costing . net income totaled If Rome had used variable costing , its net income
PlB0,000 in a period when finished-goods would have been P440,000 . Compute the breakeven
inventory level rises by 5,000 units. point in units .
Case C: Absorption-costing net income and variable-
costing net income respectively totaled P240,000 Problem 7 . Great Sense Company makes a variety of
and P272,000 in a period when the beginning instant noodles. Data related to its seafood noodle
finished-goods inventory was 14,000 units. follow:

Required: Sel ling price per cup P25

1. In Case A, how many units were sold during the
period?
2. In Case B, how much income would Relevant
Company report under variable costing?
3. In Case C, how many units were in the ending
finished-goods inventory?
Variable manufacturing cost per cup 6
Fixed manufacturing cost per month 150,C00
S&A expenses, all fixed, per month 60,000
Great Sense uses standard absorption costing, basing
its unit fixed cost on normal activity of 30,000 cups per
month. In November, Great S~nse produced 32,000

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Ex.CEL PROFESSIONAL SERVICES, INC.
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cups and sold 30,000 . There were 5,000 cups in d . fixed production costs are larger in period 2 than
beginning inventory at standard cost. All costs were period 1
incurred as expected .
3. How will a favorable volume variance affect net income
Required : under each of the following methods?
1. Determine the standard fixed cost per cup . Absorption Variable
2. Prepare an income statement for November. Use a. Reduce No effect
the short form of the income statement but b. Reduce Increase
calculate cost of goods sold separately. c. Increase No effect
3. Prepare an income statement for November d . Increase Reduce
assuming that Great Sense uses variable costing .
4. Variable costing considers which of the following to be
Problem 8. The income statement for Bryant Company for product costs? ·
2019 follows : The company has established the following Fixed Fixed Variable Variab!e
standards for a unit of finished product. Mfg S & A Mfg Costs S&A
a. Yes No Yes No
Materials (16 lbs. at PO .SO p 8 b. Yes No Yes Yes
Direct labor (2 hours at P12 24 c. No No Yes Yes
Variable OH (Pl per DLH) 2 d. No No Yes No
Fixed OH ____l
Total e.3.6 5. The variable costing format is often more useful to
managers than the absorption costing format
l he fixed overhead standard is based on normal capacity because
of 20,000 units. During 2019, 49,000 direct labor hours a. costs are classified by their behavior
were worked and 370,000 pounds of materials were used. b. it is required for external reporting
The income statement for 2019 is presented in the c. costs are always lower
opposite column . d. it justifies higher product prices

6. When a firm prepares financial reports by using

Sales (20,000 units) Pl,000,000 absorption costing
Cost of goods sold - standard 720.000 a. profits will always increase with increase in sales
Standard gross profit 280,000 b. profits will always decrease with decreases in
Variances : sales
Materials P3,000U c. profits may decrease with increased sales even if
Labor 3,000U there is no change in selling prices and costs
Variable overhead 3,000U d. decreased output and constant sales result in
Fixed overhead : increased profits
Spending 5,000F
Volume 8.000F 4.000F 7. Which of the following statements is true for a firm
Gross profit 284,000 that uses variable costing?
Selling & administrative exp . 230.000 a. The cost of a unit of product changes because of
Operating profit P 54 000 changes in the number of units manufactured
b. Profits fluctuate with sales
Required : c. An idle facility variation is calculated
1. Based on the information provided,· determine the d. None of the given choices
following :
a) Number of units produced 8. A firm presently has total sales of Pl00,000 . If its
b) Material use variance sales rise by Pl.DO its
c) Material price variance a. income based on variable costing will go up more
d) Direct labor efficiency variance than its net income based on absorption costing
e) Direct labor rate variance b. income based on absorption costing will go up
f) Variable overhead efficiency variance more than its net income based on variable
g) Variable overhead spending variance costing
h) Fixed overhead incurred c. fixed costs will also rise
2. Prepare an income statement using standard variable d. per unit variable costs will rise
costing .
9. Dredger Company manufactures a single product
Problem 8 . MULTIPLE CHOICE using standard costing. Variable production costs
1. If a firm produces more units than it sells, absorption are P12 and fixed production costs are P125,000 .
costing, relative to variable costing, will result in Dredger uses a normal activity of 12,500 units to set
a. higher income and assets its standard costs . Dredger began the year with
b. lower income but lower assets 1,000 units in inventory, produced 11,000 units, and
c. higher income but lower assets sold ii,500 units . The standard costs of goods sold
d. lower income and assets under absorption costing would be
a. PllS,000 c. P242,000
2. Under absorption costing, if sales remain constant b. P132,000 d. P253,000
from period 1 to period 2, the company will report a
larger income in period 2 when 10 . You obtain the following information regarding fixed
a. period 2 production exceeds period 1 production production costs from a manufacturing firm for fiscal
b. period 1 production exceeds period 2 production year 2015:
c. variable production costs are larger in period 2 Fixed costs in the beginnin'g inventory P 16,000
than period 1 Fixed costs incurred this period Pl00,000

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Wh ic h of the following statements Is ruu true? a. The absorption co sting Income would be P6,000
11 Th e maximum amount of fixed d
· that this firm could deduct pro uctlon costs larger
costs in 2015 is P11 6 , using absorption b. The absorption costing Income would be P6 ,000
000
b . The maximum difference b t smaller
2015 income based O e ween this firm 's c. The absorpt ion costing Income would be P4 ,800
income based on varl;bf:~orptlon, costing and Its larger
c. Using variable costln ostlng is P16,000 d . The absorpt ion costing Income would be P4 ,000
more than Pl00 g, t_ hls firm will deduct no smaller
d. If this firm P ,dooo fdor fixed product ion costs
than it Id ro uce substantially more un its 16 Assume for this question only, that Simple Corp .
so In 2015 · bl . · manufactured and sold 5,000 units in 2015 . At t_h1s
probably ield ,_ vana e costing will
. Y a lower income than absorption level of activity they had an income of P30,000 us_1~g
cos t mg
va ri ab le costing . What was the sales price per unit ,
a. P16 .00 c. Pl2 .80
Question no 11 and 12
which are · · . bl are based on the following data b. PlS .80 d. P14 .80
ava, 1a e for X Co . for its first year of
operations :
17 . Assume for th is question only, that Si_mpie Corp .
Sales in units
5,000 produced s 000 units and sold 4, 500 units in 2015 .
Production in units If Simple ~ses absorption costing , it would deduct
8,000
Manufactu ri ng costs : pe ri od costs of
Direct labor P3 per unit a. P24,000 c. P27,000
Direct materials PS per unit b. P34,000 d. P23 ,000
Variable' overhead Pl per unit
Fixed overhead Pl00,000 18. Assume for this question only, that Simp_le Corp.
Net inco~e (absorption method) P 30,000 manufactured 5,000 units and sold 4,000 tn 2015 .
Sales pnce per unit P 40 If Simple employs a costing system base~ on
variable costs, the company would end 2015 with a
l L What would X Co . have reported as Its incom ~ fin ished goods inventory of
before tax If it had used variable costing? a. P4,000 c. P6,000
a. P30,000 c. P67,500 b. PS,000 d. PS,000
b. P(7,500) d. P45,000
Questions 19 & 20 are based on the following :
12 . What was the total amount SG&A expense incurred ~ · B Co. C Cc .
by X Co .? Sales PlOO PlOO PlOO
a. P30,000 c. P6,000 Variable costs __(_Jfil --12.QJ. __Qfil
b. P62 ,SOO d. P45,000 Contribution margin P 90 P 80 P 70
Fixed costs ----2Q _2.Q _J,Q ,
13 . For its most recent fiscal year, a firm reported that Profit __efi_Q P fill LiQ
its contribution margin was equal to 40% of sales
and that its net income amounted to 10% of sales . 19. With in the relevant range, if sales go up by Pl for
If its fixed costs for the year were P60,000, how each firm, which firm will experience the greatest
much were sales? increase in profit?
a. PlS0,000 c. P600,000 a. Company A c. Company C
b. P200, 000 d. Undeterm inable b. Company B d. Not determinable

14 . At its present level of operations, a small 20 . With in the relevant range , if sale; go up by one unit
manufactu 1•ing firm has total variable costs equal to for each firm , wh ich firm will experience the greatest
75% of sa les and total fixed costs .equal to 15% of increase in net income?
sales . Based on variable costing , if sales change by a. Company A c. Company C
Pl.00, income will change by b. Company B d. Not determinable
a·. P0 .25 c. PO . 75
b. P0 . 10 d. Undeterminable 21. Southseas Corp . uses a standard cost system . The
standard cost per unit of one of Its products are as
The following information should be used to answer follows :
question nos. 15 through 18.
Direct Materials P4 .00
Simple Corp. produces a single product. The follow ing Direct labor , 6.00
cost structure applied to their first year of operations, Factory overhead
2015 : Variable 3.00
Variabl1~ costs: Fixed (based on a normal
SG&A P2 .00 per un it capacity of 10,000 un its)
Production 4.00 per unit Total
Fixed Costs (total cost incurred for the year)
SG&A . Pl4,000 Beginning inventory 2,000 units
Production P20,000 Production 8, 000 units
Units sold (selling price PSO) 7,000 units
15 . Assume for this question only, that during 2015 Act\Jal costs :
Simple Corp. manufactured 5,000 units and sold Direct materials P 35,000
3,800 . There was no beginning or ending work- in- Direct labor 50,000
process inventory . H,ow much larger or smaller Variable overhead 23 ,000
would Simple Corp .'s income be if it uses absorption Fixed
rather than variable costing? 18,000
.variab le selling and adm . 60,000
Fixed selling and adm . 35,000

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Variances are closed to cost of sales month ly. How Units In ending Inventory 300
much are the net income under absorption cost ing Variable costs per un it :
and variable costing methods? Direct materials P39
Absorption Variable Direct labor P32
a. P144 ,000 P143 ,000 Va ri able manufacturing overhead P6
b. 143,000 144,000 Variable sell ing and administrative PS
C. 144,000 142,000 Fixed costs :
d. 142,000 144,000 Fixed manufacturing overhead P6 ,800
Fixed selling and administrative PS,400
22 . A manufacturing company that produces a single
product has provided the follow ing data concern ing What is the net operatlnq income for the month
its most recent month of operations : under absorption costing?
Seliing price, PSS a. Pl4,200 c. P 1, 200
Units In beginn ing ihventory , 0 b. (PS,900) d . PlS ,400
Units produced, 2,900
Units sold, 2,700 24 . Lauder Company produces a single product. During
Units in end ing inventory, 200 March, the company had net operating income under
Variable costs per unit : absorption costing that was P3,SOO lower than under
Direct materials , P22 variable costing . The company sold 7,000 units in
Direct labor., P13 March, and its variable costs were P7 per unit, of which
Variable manufacturing overhead, P3 P3 was variable selling expense. If fixed manufacturing
Variable selling and administrative, PS overhead was P2 per unit under absorption costing ,
Fixed costs : then how many units did the company produce during
Fixed manufacturing overhead, P46,400 March? .
Fixed sellin~1 and administrc!tive , PSl,300 a; 5,250 units c. 6,500 units
b. 8,750 units d. 6,125 units
What is the net operating income for the month
under variable costi'ng? 25 . Company B produces a single product. Last year, the
a. P 8 , 100 c. P18,900 company had 16,000 units in its beginning inventory .
b . PlS,700 d . P 3,200 During the year, the company's variable production
costs were P6 per unit and its fixed manufacturing
23 . A manufacturing company that produces a single overhead costs were P4 per unit. The company's net
product has provided the following data concerning its operating income for the year was P24,000 higher
most recent month of operations : under absorption _costing than it was under variable
Sell ing price P103 costing. Given these facts, the number of units in the
Units in bEiginning inventory 0 ending ·inventory must have been :
Units prod·uced 1,700 a. 22,000 units c. 6,000 un its
Un its sold 1 ,400 b. 10,000 units d . 4,000 units

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