variable costing vs. absorption costing

7/25/2019 Variable Costing vs. Absorption Costing

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Variable Costing vs. Absorption Costing

Let’s take a look at the overview of these costing approaches:

Garrison and Noreen, (2013)

The above power point presentation slide illustrates a manufacturing business coststructure. Take note of the Fied !anufacturing "verhead# there lies the di$erencebetween the two methods.

From the %ncome &tatement that 'ou have learned in 'our previous ma(orsub(ects like Fundamentals of Accounting# Financial Accounting# and Cost

Accounting# the operating performance of an entit' for a period ended on a certaindate can be a net pro)t or a net loss. Then# looking at the Cost of *oods &oldsection# there is this Finished Goods Inventory, End or MerchandiseInventory # where +nd is deducted from the items available for sale. Thus# theending )nished goods inventor' contributes to an increase in net pro)t. Can 'oustill remember that these accounts are used under the periodic inventor' costingmethod, The' remain unsold for a certain period that ended- therefore# the' arenot classi)ed costs of goods sold.

%n this module# the cost/ classi)cation will be product or period costs# andvariable or )ed costs. For a manufacturer# the valuation of inventories 0or productcosts1 and the cost of goods sold 0or period costs1# in total or on a per unit basis are

ver' important. Full absorption costin and variable costin are other costclassi)cations that we will learn this time. For 'our information# the %ncome&tatement that 'ou prepared in 'our previous accounting sub(ects 0FundamentalAccounting# Financial Accounting and Cost Accounting1 is that of a !ull absorptioncostin approach. !oreover# the' are prepared to cater to the needs of eternalinformation users. From the income statement of a manufacturer# 'ou identi)edthat the inventories are product costs while the cost of goods sold is a period cost.&upplementar' to the income statement is the Cost of *oods !anufactured# which




presents the total product or manufacturing costs: the direct materials# direct laborand manufacturing overhead. Fied and variable costs do not appear in thestatement# but take note that this manufacturing cost is composed of variable and)ed costs.

Another costing approach used in the income statement report is variable

costin. This costing method speci)call' caters to the needs of managers# a basictool in their decision "a#in aenda.

2ow do we di$erentiate absorption costing from variable costing, To distinguishone from the other# presented below is a summar' of variable costing againstabsorption costing:

E$%I&I' 1 *ariable +ostin versus bsorption +ostin (Garrison andNoreen, 2010)




Another issue to be considered in absorption and variable costing methods is theincome e$ect of the si3e of inventor' at the end of a particular reporting period. Thematri that follows shows 0+hibit 4561 the Comparative %ncome +$ects 7 Absorptionand Variable Costing 0*arrison and 8oreen 69th +d. ;6; page <=.

RELATION

BETWEEN

PRODUCTIO

EFFEC

T ON

INVEN

RELATION BETWEEN

ABSORPTION AND

VARIABLE COSTING NET




N AND

SALES FOR

THE

PERIOD

TORIE

S

OPERATING INCOME

>nitsproduced

?

8ochangeininventories

AbsorptionCosting8etoperatingincome

? Variablecosting8et operatingincome

>nits@roduced

%nventor'%ncrease

Absorption Costing8etoperating%ncome

VariableCosting8et"perating%ncomeB

>nits@roduced

%nventoriesDecrease

AbsorptionCosting8et"perating%ncome

VariableCosting8et "perating%ncomeBB

B8et operating income is higher under absorptioncosting because )ed manufacturing overhead cost

is de!erred in inventor' under absorption costingas inventories increase.

BB 8et operating income is lower under absorptioncosting because )ed manufacturing overheadis released from inventor' under absorptioncosting as inventories decrease.

As mentioned earlier in the )rst part of this module# the two costing methods areapplied in the income statement report. @resented hereunder are two incomestatements illustrating the absorption and variable costing methods. From the twoincome statements# take note of the di$erence in net operating income brought b'the )ed manufacturing component of the ending inventor' under the absorptioncosting method.




Absorption Costing !ethod:

&ales 06E#;;; units @hp; perunit.

@hp 9;;#;;;

Less: Cost of *oods &old

Geginning %nventor' @hp5;5

Add: Cost of goods manufactured 06=#;;; units @hp6 per unit1

6H#;;;

*oods available for sale. @hp 6H#;;;

Less: +nding %nventor'06#;;; units @hp6B per unit1

6#;;;BB

Cost of *oods &old.. 6<;#;;;

*ross !argin. @hp 6;#;;;

Less: &elling and Administrative+penses

Variable: 6E#;;; units @hp9 ?@hpIE#;;; 0 @hpIE#;;; J @hp9;#;;; )ed 1

4E#;;;

8+T "@+KAT%8* %8C"!+

@hp IE#;;;??????????

Variable Costing !ethod:

&ales 06E#;;; units @hp; per unit1.

@hp9;;#;;;

Less: Variable +penses

Variable Cost of *oods &old:

Geginning %nventor'. @hp 5;5

Add: Variable !anufacturing Costs 06=#;;; units @hp4 per >nit1..

66#;;;




*oods available for sale.. @hp66#;;;

Less: +nding %nventor' 06#;;; units @hp4 per unit1

4#;;;BBB

Variable Cost of *oods &old. @hp6;E#;;;

Variable &elling and Administrative+penses 06E#;;; units @hp91

IE#;;;

6E;#;;;

Contribution !argin. @hp6E;#;;;

Less: Fied +penses

Fied !anufacturing "verhead.. @hp H;#;;;

Fied &elling and Administrative +penses.

9;#;;; @hp66;#;;;

8+T "@+KAT%8* %8C"!+

@hpI;#;;;??????????

B The assumed ending inventories of @hp6.;; per unit have a )edmanufacturing overhead cost components of @hpE.;; per unit.

BB >nder the Absorption Costing approach the @hp6 per unit includes the)ed manufacturing cost component of ending inventories.

BBB

%n the net income statement 0variable costing approach1# the endinginventories deducted from the goods available for sale are purel' variablecosts.

The )ed component of manufacturing overhead is included in the@hpH;#;;; Fied !anufacturing "verhead. Thus# this eplains thedi$erence in net operating income between the two approaches 0which is6#;;; units @hpE.;; ? @hpE#;;;1. &peci)call'# it is the )edmanufacturing cost component of the ending inventories.

To help 'ou understand the impact of variable costing and absorption costing in thedecision5making process of management likewise# to appreciate the role of!anagement Accounting# read the following topics pages << 5 H6 of our tetbook.

variable costing vs. absorption costing

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