MAS_1.2.

4 INTEGRATED REVIEW & REFRESHER IN ACCOUNTANCY

R.D.BALOCATING

UNIVERSITY OF LUZON
COLLEGE OF ACCOUNTANCY

MANAGEMENT ADVISORY SERVICES

VARIABLE COSTING AND ABSORPTION COSTING
 Variable costing – also known as direct costing, is an approach to product costing that assigns only variable manufacturing
costs (direct materials, direct labor and variable factory overhead) to items produced.
 Absorption costing – also known as full production costing or conventional costing, the method typically used for external
income statement reporting, allocates all manufacturing costs (variable and fixed) to items produced.
 Product and period costs under absorption and variable costing are summarized below:
For External Reporting* For Internal Decision Making
Absorption Costing Variable Costing

Product costs: direct materials (DM) direct materials (DM)

direct labor (DL) direct labor (DL)
variable overhead (VOH) variable overhead (VOH)
fixed overhead (FOH)
Period costs: variable selling expenses fixed overhead (FOH)
fixed selling expenses variable selling expenses
variable administrative expenses fixed selling expenses
fixed administrative expenses variable administrative expenses
fixed administrative expenses

*PAS 2 paragraph 12. The costs of conversion of inventories include costs directly related to the units
of production, such as direct labour. They also include a systematic allocation of fixed and variable
production overheads that are incurred in converting materials into finished goods.

 Income Statements: Analysis and Reconciliation

 Under absorption costing, costs are classified by function as:
1. manufacturing costs (both fixed and variable)
2. selling and administrative costs (both fixed and variable)

The format used when costs are classified by function for absorption costing is:
Sales
– Cost of goods sold
= Gross margin
– Selling and administrative expenses
= Net income

 When variable costing is used, costs are classified by behavior as:

1. variable costs
a. variable manufacturing b. variable selling and administrative
2. fixed costs
a. fixed manufacturing b. fixed selling and administrative
The format used for a variable-costing income statement follows:
Sales
– Variable expenses:
Variable cost of goods sold
Variable selling and administrative
= Contribution margin
– Fixed expenses:
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MAS_1.2.4 INTEGRATED REVIEW & REFRESHER IN ACCOUNTANCY
R.D.BALOCATING
Fixed overhead
Fixed selling and administrative
= Net income
 Production, sales, and income relationships:
If Then
Production > Sales Absorption net income > Variable net income
Production < Sales Absorption net income < Variable net income
Production = Sales Absorption net income = Variable net income
 The difference between absorption-costing income and variable-costing income results from differences in the timing
of the recognition of fixed manufacturing overhead costs as an expense.
 Variable costing always recognizes the period’s fixed overhead as an expense.
 Absorption costing recognizes as an expense only the fixed overhead attached to the units sold.
 Reconciliation of Variable and Absorption Costing Net Income
Absorption Costing Net Income xxx
Add: Fixed Overhead in Beg. Inventory xxx
xxx
Less: Fixed Overhead in Ending Inventory xxx
Variable Costing Net Income xxx
 Advantages of Variable Costing
The arguments for variable costing include the following:
1. Cost-volume-profit relationship data needed for profit-planning purposes are readily available from the regular
accounting records and statements.
2. Since fixed factory overhead is not included in inventory cost, increases or decreases in inventory have no effect on
the reported profit for the period.
3. Management finds it easier to understand and used variable costs reports because such reports follow management’s
thinking more closely than do absorption costing statements.
4. The impact of fixed costs on profits is emphasized because the total amount of such cost for the period appears in
the income statement.
5. Marginal income figures facilitates the appraisal of products, territories, classes of customers, and other segments of
the business without having the result obscured by allocation of joint fixed costs.
6. Variable costing is based on the same concepts that underlie flexible budgets, breakeven analysis and standard
costs, thus facilitating the adoption and use of these techniques for management planning and control.
7. Under variable costing, costs assigned to inventory conform closely with management’s concept of inventory cost as
the current out of pocket expenditures necessary to manufacture the goods.
8. The computation of product costs under variable costing is simpler and less expensive because allocation of fixed
costs on inventories is eliminated.
9. Profits reported under variable costing are more accurate because only variable costs are identified with production.
Fixed costs are expenses of maintaining productive capacity. Such expenses occur with the passage of time, not the
utilization of the facilities.
 Disadvantages of Variable Costing
The arguments against (disadvantages of) variable costing include the following:
1. It may be difficult, if not impossible, to segregate all costs into their fixed and variable components. Some costs are
semi-variable in nature and fixed costs will vary at some level of production.
2. Long-range policy decisions must take into consideration the total cost of production. Direct costing requires
additional computations to determine total costs.
3. Variable costing violates the principle of matching costs with revenues because fixed manufacturing costs are
excluded from total production costs and inventory. Production cannot be carried on without using plant facilities and
other fixed factory overhead.
4. Inventory is understated because of the elimination of fixed manufacturing overhead.
5. Variable costing is not accepted for income tax purposes
6. Variable costing does not conform to the generally accepted accounting principles.

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R.D.BALOCATING
MULTIPLE CHOICE:
1. ABC Co.’s 2015 fixed manufacturing overhead costs totaled P100,000, and variable selling cost totaled P80,000. Under
variable costing, how should these costs be classified?
Period Costs Product Costs Period Costs Product Costs
a. P0 P180,000 c. P100,000 P80,000
b. P80,000 P100,000 d. P180,000 P0

2. Which of the following is an argument against the use of variable costing?

a. Absorption costing overstates the balance sheet value of inventories
b. Variable factory overhead is a period costs
c. Fixed factory overhead is difficult to allocate properly
d. Fixed factory overhead is necessary for the production of a product

3. Absorption costing and variable costing are different methods of assigning costs to units produced. Which cost item listed
below is not correctly accounted for as a product cost?
Part of Product Cost Under
Absorption Costing Variable Costing
a. Manufacturing supplies Yes Yes
b. Insurance on factory Yes No
c. Direct labor cost Yes Yes
d. Packaging and shipping cost Yes No

4. A company manufactures and sells a single product. Planned and actual production in 2015, its first year of operation,
was 100,000 units. Planned and actual costs in 2015 were as follows:
Manufacturing Non-manufacturing
Variable P600,000 P500,000
Fixed P400,000 P300,000

The company sold 85,000 units of product in 2015 at a selling price of P30 per unit. Using absorption costing, the
company’s operating income in 2015 would be:
a. P750,000 b. P900,000 c. P975,000 d. P1,020,000

5. (Refer to information in no. 4) Using variable costing, the company’s operating income in 2015 would be:
a. P750,000 b. P840,000 c. P915,000 d. P975,000

6. During its first year of operations, a company produced 275,000 units and sold 250,000 units. The following costs were
incurred during the year:
Variable cost per unit:
Direct materials P15.00
Direct labor 10.00
Manufacturing overhead 12.50
Selling and administrative 2.50
Total fixed costs:
Manufacturing P2,200,000
Selling and administrative 1,375,000
The difference between operating income calculated on the absorption costing basis and on the variable costing basis is
that absorption costing operating income is:
a. P200,000 greater b. P220,000 greater c. P325,000 greater d. P62,500 less

7. Ortiz Company’s records for the year ended December 31 show that no finished goods inventory existed at January 1
and no work was in process at the beginning or end of the year. Other data are as follows:
Net sales P1,400,000
Cost for goods manufactured:
Variable 630,000
Fixed 315,000
Operating expenses:
Variable 98,000
Fixed 140,000
Units manufactured 70,000
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R.D.BALOCATING
Units sold 60,000
What is Ortiz’ finished goods inventory cost at December 31, under the variable costing method?
a. P90,000 c. P105,000
b. P104,000 d. P135,000

8. (Refer to information in no. 7) Under the absorption costing method, operating income for the year is:
a. P217,000 b. P307,000 c. P352,000 d. P762,000

NEXT FOUR QUESTIONS ARE BASED ON THE FOLLOWING INFORMATION.

The annual flexible budget below was prepared for use in making decisions relating to Product X
100,000 units 150,000 units 200,000 units
Sales volume P800,000 P1,200,000 P1,600,000
Manufacturing costs:
Variable P300,000 P450,000 P600,000
Fixed 200,000 200,000 200,000
P500,000 P650,000 P800,000
Selling and other expenses:
Variable P200,000 P300,000 P400,000
Fixed 160,000 160,000 160,000
P360,000 P460,000 P560,000
Income or (loss) (P 60,000) P 90,000 P240,000

The 200,000 unit budget has been adopted and will be used for allocating fixed manufacturing costs to units of Product
X. At the end of the first 6 months, the following information is available:

Production completed 120,000 units

Sales 60,000 units

All fixed costs are budgeted and incurred uniformly throughout the year, and all cost incurred coincide with the budget.
Over and under applied fixed manufacturing costs are deferred until year-end. Annual sales have the following seasonal
pattern:
Portion on annual sales
First quarter 10%
Second quarter 20%
Third quarter 30%
Fourth quarter 40%

9. The amount of fixed costs applied to product during the first 6 months under absorption costing is:
a. overapplied by P20,000 c. underapplied by P40,000
b. equal to the fixed cost incurred d. underapplied by P80,000

10. Reported net income or (loss) for the first 6 months under absorption costing is:
a. P160,000 b. P0 c. P40,000 d. (P40,000)

11. Reported net income or (loss) for the first 6 months under variable costing is:
a. P180,000 b. P40,000 c. P0 d. (P180,000)

12. During the first year of operation, Marco Mfg. Co. manufactured 5 million units, of which 4 million were sold.
Manufacturing costs for the year were as follows:

Fixed manufacturing cost P10,000,000

Variable manufacturing cost P3 per unit

Which of the following answer is incorrect? (In all cases, assume that the unit sales for the year remain at 4 million)
a. Under variable costing, income from operation will be P2,000,000 less than full costing
b. Under full costing, the cost of goods sold would have been P2 million greater if Marco had manufactured only 4 million
units during the year
c. Under variable costing, the amount of manufacturing costs deducted from revenue during the year will be P22 million,
regardless of the number of units manufactured
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R.D.BALOCATING
d. Under full costing, Marco’s net income would have been higher for the first year of operations if fewer units had been
manufactured.

13. The results of Cougar Company’s first year of operations disclosed the following:

Fixed production costs (actual and budgeted) P20,000

Fixed selling and adm. expenses 15,000
Variable production costs per unit P12.00
Variable selling and adm. expenses per unit 1.00
Actual production 8, 000 units
Normal capacity 10,000 units
Units sold 7,800

Any under or over applied overhead is treated as adjustment to costs of goods sold. Using absorption costing, what is
the adjusted cost of sales?
a. P102,900
b. P109,200
c. P113,200
d. P121,000

14. Which of the following is FALSE?

a. There is no capacity variance under the direct costing method
b. If sales are less than production (in units), the net income under absorption costing is higher than the net income
under variable costing
c. The profit difference between direct costing and absorption costing is due to the difference in inventory valuation
d. Profits under absorption costing are influenced by the sales volume

15. Sales and costs data for Mariposa Company’s new product are as follows:
Sales (P22.50 per unit) P225,000
Variable mfg. costs per unit 12.00
Variable selling and adm. costs per unit 4.50
Annual fixed costs:
Manufacturing P37,500
Selling and adm. P22,500

There was no inventory at the beginning of the year. Normal capacity is 12,500 units. During the year 12,000 units were
manufactured.

The cost of ending inventory would be

Direct costing Absorption costing
a. P30,000 P37,500
b. 24,000 30,000
c. 37,500 30,000
d. 24,000 37,500