Absorption vs. Variable Costing (OK Na!)

UNIVERSITY OF SAINT LOUIS-TUGUEGARAO
School of Business Administration and Accountancy, 2013-2014

Junior Philippine Institute of Accountants
MEMORY AID IN MANAGEMENT ADVISORY SERVICES
Any form of reproduction of this copy is strictly prohibited!!!
CHAPTER 6:
Product costing: Absorption , Variable and Throughput Costing
☛Absorption Costing DISTINCTIONS BETWEEN PERIOD COSTS AND
PRODUCT COSTS
 also called full costing or conventional
costing Period Cost Product Cost
 A product costing method that includes all -Cost that is charged -Cost that is included in
manufacturing costs (direct materials, against current the computation of
direct labor and both variable and fixed revenue during a time product cost that is
overhead) as product costs. period regardless of apportioned between
 Presents nonmanufacturing costs on the the difference between the sold and unsold
income statement according to functional production and sales units.
areas. volumes.
 Under this method, fixed factory overhead
is treated as a product cost.
-Does not form part of -An inventoriable cost.
☛Variable Costing the cost of inventory The portion of the cost
that has been allocated
 also called direct costing, marginal to the unsold units
costing or contribution margin becomes part of the
reporting. cost of inventory.
 A product costing method that includes
only variable costs of production (direct -Diminishes income for -Diminishes current
materials, direct labor, and variable the current period by income by the portion
manufacturing overhead) as product costs. its full amount. allocated to the sold
 Presents both nonmanufacturing and units; the portion
manufacturing costs on the income allocated to unsold
statement according to cost behavior. units is treated as an
 Under this method, fixed factory overhead asset, being part of
is treated as a period cost. bthe cost of inventory
PRODUCT COST COMPONENTS

VARIABLE COSTING: ARGUMENTS
Absorption Costing Variable Costing
FOR AGAINST
Direct materials Direct materials
*Reports are simpler and *Segregation of costs
+ Direct labor + Direct labor
more understandable into fixed and variable
+ Variable OH + Variable OH
*Applicable for break- might be difficult
+ Fixed OH ---
even and CVP analysis *Matching principle is
----------------------- -----------------------
*Problems involved in violated for it excludes
Product Cost Product Cost
allocating fixed costs are fixed OH from product
Management Advisory Services (MAS) Committee: Hazeleen Martinez; Jimmy Joe Miranda; Cliff Mark Confidente;
23 Corina Bariuan; Kristina Gaddon; Rizalyn Taguibao ;Niῆo Rey Mangupag; Marjhon Maramag; Leo Jay Labasan
Adviser: Mary Queen Ramos, CPA
eliminated costs substantially the same results

*More compatible with *Inventory costs and since sales cannot continually
standard cost accounting other related accounts, exceed production, nor
system such as working capital, production can continuously
*Reports provide useful current ratio, and acid- exceed sales.
information for pricing test ratio, are
decisions and other understated because of
decision-making the exclusion of fixed OH Sales and variable costing, production and
problems encountered in the computation of absorption costing. (Which follows which?)
by mgmt. product costs. o Variable costing income follows sales;
that is:
Absorption Variable Table 1: Variable Costing

1. Cost Seldom Costs are If
segregation segregate costs segregated into Therefore, S>P S<P S=P
into variable variable and
VC no change
and fixed fixed
Operating (ceteris
2. Cost of Includes all the Includes only
Income Increases Decreases paribus)
inventory manufacturing VARIABLE
costs manufacturing Inventory Decreases Increases no change
costs
3. Treatment of Treated as Treated as VC Fixed OH equal to
Fixed OH PRODUCT COST PERIOD COST expense is < than AC > than AC AC
4. Income Distinguishes Distinguishes
statement between between VC
production and variable and Operating equal to
other costs fixed costs Income is > than AC < than AC AC
S XX S XX
-CGS(prod’n -VC XX o Absorption costing income follows
cost) XX CM XX production; that is:
Gross profit XX -Fixed costs XX
Table 2: Absorption Costing
-S&A costs XX Profit XX
Profit XX If
5. Net Income Net Income between the two Therefore, P>S P<S P=S
methods may differ from each AC no change
other because of the difference in Operating (ceteris
the amount of fixed OH costs Income Increases Decreases paribus)
recognized as expense during an Inventory Increases Decreases no change
accounting period. This is due to
AC Fixed
variations between sales and
OH expense
production. in the long run,
is < than VC > than VC equal to VC
however, both methods give
Management Advisory Services (MAS) Committee: Hazelyn Martinez; Jimmy Joe Miranda; Cliff Mark Confidente;
AC 1. SUPERVARIABLE COSTING OR THOUGHPUT

Operating COSTING- treats direct materials as the only variable
Income is > than VC < than VC equal to VC costs.
Let P=Production
S= Sales ☛FEATURES:
AC=Absorption Costing a. Only material costs are inventoried; work-in
VC=Variable Costing process or finished goods inventories are not
recorded
RECONCILIATION OF ABSORPTION AND VARIABLE b. Treats all direct labor and manufacturing OH costs
COSTING INCOME FIGURES as period costs, expensing them as they are incurred.
c. COGS is the cost of materials put into process.
Absorption costing income XX d. Sales – COGS= Throughput in TOC parlance
Add: Fixed OH in the beginning inventory XX e. While variable costing neither rewards nor
Total XX penalizes production that is higher or lower than
Less: Fixed OH in the ending inventory XX sales, throughput costing penalizes high production
Variable costing income XX and rewards low production. Throughput costing is
therefore very much in tune with JIT and other
ACCOUNTING FOR DIFFERENCE IN INCOME philosophies that seek lower inventories.
2. SUPERABSORPTION COSTING- treats costs from

Change in inventory (Production less Sales) XX
all links in the value chain as inventoriable costs.
X Fixed FOH cost per unit XX
Difference in income XX
 [NOTE:]When Production>Sales: Throughput
STANDARD COSTS UNDER ABSORPTION AND income<Variable income<Absorption income.
VARIABLE COSTING
When Sales>production: Throughput
1. COGS is computed at standard income>Variable income>Absorption
income.
2. Standard COGS is adjusted to actual costs by
adding unfavorable variances and/or deducting Once a company has reduced
favorable variances inventories to near zero: Throughput
income=Variable income=Absorption
3. In absorption costing, both variable and fixed
income.
manufacturing cost variances are used as
adjustment to the std. COGS ☛Treatment of costs variance
4. In variable costing, only the variable
manufacturing cost variances are used as Cost variance
adjustments to the std. COGS.
 the difference between actual and
standard amounts.
THE EXTREMES
variance treatment
Actual costs > standard costs Unfavorable variance Added to cost of goods sold at
standard/ deducted from
operating income
Actual costs< standard costs Favorable variance Deducted from cost of goods sold
at standard/ added to operating
income
Computation of operating profit with costs variances:
Absorption costing Variable costing
Sales QS x USP XX XX
Variable CGS QS x UVC (XX) (XX)
Fixed OH QS x UFC (XX) ---
NC x UFC --- (XX)
Variable production costs variances
Unfavorable (XX) (XX)
Favorable XX XX
Volume variance
Unfavorable (XX) ---
Favorable XX ---
Operating income XX XX
Variance Treatment
Normal capacity > actual capacity unfavorable Added to cost of goods sold at
standard or deducted from
operating income
Normal capacity < actual capacity favorable Deducted from cost of goods sold
at standard or added to operating
income
Volume variance Computation of volume variance:

 applicable only in the absorption
costing Normal capacity in units xx
 happens when the normal capacity is - Actual capacity in units xx
not equal to the actual capacity. Volume variance in units xx
Normal capacity X standard fixed costs per unit xx
 the average level of activity over a long Volume variance in pesos xx
period or over the budgeting period.
 {QUICK CHECK} ???
SAMPLE PROBLEM 1:
Bach Inc. makes a single product that sells for $40. The standard variable manufacturing cost is $22 and the
standard fixed manufacturing cost is $8, based on producing 30,000 units. During the year Bach produced 28,000
units and sold 26,000 units. Actual fixed manufacturing costs were $235,000; actual variable manufacturing costs
were $595,000. Selling and administrative expenses were $95,000. There were no beginning inventories.
a. Prepare a standard absorption costing income statement.
b. Prepare a standard variable costing income statement.
SOLUTION:
a. Sales (26,000 x $40) $1,040,000 b. Sales $1,040,000

COGS (26,000 x $30) $780,000 Variable Costs (26,000 x $22) $572,000
Variances: Variable Spending Variance (21,000) F
Variable Spending $(21,000) F Adjusted Variable Cost of Goods Sold 551,000
Fixed Spending ( 5,000) F Contribution Margin $489,000
Volume 16,000 U (10,000)
Adjusted Cost of Goods Sold 770,000 Fixed Costs:Manufacturing 235,000
Gross Profit $270,000 Selling & Administrative 95,000 330,000
Selling & Administrative 95,000 Net Income $159,000
Net Income $175,000
SAMPLE PROBLEM 2:
Coastal Corporation, which uses throughput costing, began operations at the start of the current year.
Planned and actual production equaled 20,000 units, and sales totaled 17,500 units at $95 per unit. Cost data for
the year were as follows:
Direct materials (per unit) $ 18

Conversion cost:
Direct labor 160,000
Variable manufacturing overhead 280,000
Fixed manufacturing overhead 340,000
Selling and administrative costs (total) 430,000
The company classifies direct materials as a throughput cost.
Required:
A. Compute the company's total cost for the year.

B. How much of this cost would be held in year-end inventory under (1) absorption costing, (2) variable
costing, and (3) throughput costing?
C. How much of the company's total cost for the year would appear on the period's income statement
under (1) absorption costing, (2) variable costing, and (3) throughput costing?
D. Compute the year's throughput-costing net income.
SOLUTION:
A. Direct materials (20,000 units x $18) $ 360,000

Direct labor 160,000
Variable manufacturing overhead 280,000
Selling and administrative costs 430,000
Total $1,570,000
B. The year-end inventory of 2,500 units (20,000 - 17,500) is costed as follows:
Absorption Variable Throughput

Costing Costing Costing
Direct materials $ 360,000 $360,000 $360,000
Direct labor 160,000 160,000
Variable manufacturing overhead 280,000 280,000
Total product cost $1,140,000 $800,000 $360,000
Cost per unit (Total ÷ 20,000 units) $57 $40 $18
Year-end inventory (2,500 units x cost per
unit) $142,500 $100,000 $45,000
C. The total costs would be allocated between the current period's income statement and the
year-end inventory on the balance sheet. Thus:
Absorption costing: $1,570,000 - $142,500 = $1,427,500

Variable costing: $1,570,000 - $100,000 = $1,470,000
Throughput costing: $1,570,000 - $45,000 = $1,525,000
D. Throughput income: Sales revenue (17,500 units x $95) - $1,525,000 = $137,500

Absorption vs. Variable Costing (OK Na!)

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UNIVERSITY OF SAINT LOUIS-TUGUEGARAO

School of Business Administration and Accountancy, 2013-2014

PRODUCT COST COMPONENTS

eliminated costs substantially the same results

Absorption Variable Table 1: Variable Costing

AC 1. SUPERVARIABLE COSTING OR THOUGHPUT

2. SUPERABSORPTION COSTING- treats costs from

Computation of operating profit with costs variances:

Absorption costing Variable costing

Volume variance Computation of volume variance:

 {QUICK CHECK} ???

a. Prepare a standard absorption costing income statement.

b. Prepare a standard variable costing income statement.

a. Sales (26,000 x $40) $1,040,000 b. Sales $1,040,000

Direct materials (per unit) $ 18

A. Compute the company's total cost for the year.

A. Direct materials (20,000 units x $18) $ 360,000

B. The year-end inventory of 2,500 units (20,000 - 17,500) is costed as follows:

Absorption Variable Throughput

Absorption costing: $1,570,000 - $142,500 = $1,427,500

D. Throughput income: Sales revenue (17,500 units x $95) - $1,525,000 = $137,500

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