ACT122: Strategic Cost Management

Product Costing

Product costing involves the assignment of costs to the output produced by the company. This usually
serves as the basis for determining selling prices as well as inventory cost allocation.

Three approaches to Product Costing

Absorption costing – treat all manufacturing costs as product costs regardless whether fixed or
variable.

Variable Costing (direct costing) – only variable manufacturing costs are treated as product costs; the
rest (fixed manufacturing and all commercial costs regardless whether fixed or variable) are regarded
as period costs.

Throughput Costing (super-variable costing) – only direct materials are treated as product cost; the
rest (direct labor, factory overhead and all commercial costs regardless whether fixed or variable) are
regarded as period costs.
Throughput Contribution = Revenue – Direct Materials

Product Costing Technique

Absorption Costing Variable Costing Throughput Costing
(Full Costing) (Direct Costing) (Throughput Costing)
Inventoriable Cost
Direct Materials Direct Materials Direct Materials
Direct Labor Direct Labor
Var. Overhead Var. Overhead
Fixed Overhead
Unit Product Cost Unit Product Unit Product Cost
Cost

Expenses
Var. Selling Var. Selling Var. Selling
Var. Admin Var. Admin Var. Admin
Fixed Selling Fixed Selling Fixed Selling
Fixed Admin Fixed Admin Fixed Admin
Fixed Overhead Direct Labor
Var. Overhead
Fixed Overhead
Total Expenses Total Expenses Total Expenses
Income Statement Preparation
A. Based on Absorption Costing: (GAAP and for external reporting)
Sales Pxx
Less Cost of Sales
Finished Goods Inventory, beg. Pxx
Cost of Good Manufactured* xxx
Total Goods Available for Sale Pxx
Less Finished Goods, Inventory, end** (xx) Pxx
Gross Margin Pxx
Less Variable Selling and Administrative Expenses xx
Fixed Selling and Administrative Expenses xx
Net Income Pxx
*Full or Absorption Cost X Units Produced
**Full or Absorption Cost X Units in Ending Inventory

B. Based on Variable Costing:

Sales Pxx
Less Variable Manufacturing Costs* (Pxx)
Manufacturing Contribution Margin Pxx
Less Variable Selling and Administrative Expenses (xx)
Contribution Margin Pxx
Less Fixed Manufacturing Exp (Fixed Overhead) (xx)
Fixed Selling and Administrative Expenses (xx)
Net Income Pxx
*Variable Manufacturing Costs X Units Sold

C. Based on Throughput Costing

Sales
Less Cost of Sales (Units sold x Standard Direct Material Cost)
Throughput Margin
Less: Operating Costs
Direct Labor
 Variable Manufacturing Overhead
Fixed Manufacturing Overhead
Variable Selling and Administrative Expenses
Fixed Selling and Administrative Expenses
Net Income

Take note that the Income Statement approach under Absorption costing follows the traditional
approach with emphasis on GAAP principle of matching. Costs are properly matched with the
corresponding revenues generated.
Income statement under Variable costing segregates costs based on cost behavior (i.e. variable costs
and fixed costs). Though it is not considered GAAP, it has proven its worth in management accounting
particularly regarding CVP Analysis and performance measurement.

Points to consider:
1. In the variable costing, the whole amount of fixed overhead is treated as a period cost – meaning
expensed entirely in the current period regardless of production. In absorption costing, it is allocated
between cost of sales and ending inventory.
2. The difference in net income between variable costing and absorption costing therefore lies in the
fixed overhead costs assigned to the beginning and ending inventory.
3. In both variable and absorption costing, variable and fixed selling and administrative expenses are
regarded as period costs.

Illustration 1
Dakki Pillow Company’s planned production for the year just ended was 10,000 units. This production
level was achieve but only 9,000 units were sold. Other data follows:
Direct Materials used P80,000
Direct Labor incurred P40,000
Fixed manufacturing overhead P50,000
Variable manufacturing overhead P24,000
Fixed selling and administrative expenses P60,000
Variable selling and administrative expenses P9,000
Finished goods inventory, January 1 None
Required: What would be Dakki Pillow Company’s finished goods inventory cost on December 31
under:
a. Absorption Costing
b.Variable Costing
c.Throughput Costing

llustration 2
Heaven Company had the following information provided for analysis:
Units in beginning inventory 0
Units produced 6,000
Units sold 5,000
Units in ending inventory 1,000

Selling price per unit P20

Direct Materials per unit P2
Direct Labor P4
Variable Manufacturing Overhead P1
Fixed Manufacturing Overhead P5
Selling and administrative expenses Variable P3
Fixed Selling P10,000

Unit Cost Computation Absorption Variable

Direct Materials P2 P2
Direct Labor P4 P4
Var Mftg Overhead P1 P1
Fixed Mftg Overhead P5 ____
Total Unit cost P12 P7
Required: Income Statement each method.

Exercise 1:
Fill in the blanks for each of the following independent situations. In all situations, selling price is P10
standard and actual variable manufacturing cost is P6. Fixed production costs – budgeted and actual –
are P100,000 and the volume used to set the standard fixed cost per unit is 50,000 units. There are
no selling and administrative expenses.
Alpha Bravo Charlie
Units Sold 80,000 50,000
Units Produced 55,000
NI (Direct costing) 220,000 80,000
NI (Absorption costing) 210,000 120,000
Exercises 2:
Toshiba Company produces and sells a single product, wooden cars decorative items. Selected cost
and operating data relating to the product for two years are given below:
Selling price per unit P50
Manufacturing costs
Direct Materials P11
Direct Labor P6
Variable Overhead P3
Fixed Overhead per year P120,000
Selling and administrative expenses
Variable per unit sold P5
Fixed cost per year P70,000
Year 1 Year 2
Units in beginning inventory 0 2,000
Units produced during the year 10,000 6,000
Units sold during the year 8,000 8,000
Units in ending inventory 2,000 0
Required:
1. Assume that the company uses absorption costing
a. Compute the unit product cost in each year.
b. Prepare an income statement for each year

2. Assume that the company uses variable costing

a. Compute the unit product cost in each year.
b. Prepare an income statement for each year

3. Reconcile the variable costing and absorption costing net income figures.

THEORY
1. To apply direct costing method it is necessary that you know
A.Standard production rate and times of production elements
B.Contribution margin and break even point in production
C.Variable and fixed cost related to production
D.Controllable and uncontrollable cost of production
2.The following statements about the adoption of variable costing are true, except:
A. All fixed manufacturing costs are recognized as period costs.
B. A direct cost may not become a product cost.
C. It is an acceptable method for general reporting purposes.
D. An indirect cost may be assigned as part of product cost.
3. The change in period-to-period operating income when using variable costing can be explained by
the change in the
A. Unit sales level multiplied by the unit sales price.
B. Finished goods inventory level multiplied by the unit sales price.
C. Unit sales level multiplied by a constant unit contribution margin.
D. Finished goods inventory level multiplied by a constant unit contribution margin.
4. Which of the following is NOT an advantage of using variable costing for internal reporting
purposes?
A. Fixed costs are reported at incurred values, not absorbed values, thus improving control
over those costs.
B. Profits are directly influenced by changes in sales volume.
C. The impact of fixed costs on profits is emphasized.
D. Total costs may be overlooked when evaluating profits.
6. A cost that is included as part of product costs under both absorption costing and direct costing is:
A. managerial staff costs D.taxes on factory building
B. insurance E. variable materials handling labor
C. variable marketing expenses.
7. Under variable costing,
A.all product costs are variable.
B. all period costs are variable.
C. all product costs are fixed
D. product costs are both fixed and variable.
8. Which of the following is not associated with absorption costing?
A. functional format C. Period costs
B. gross margin D. contribution margin
9. Calculating income under variable costing does NOT require knowing
A. unit sales. C. unit variable manufacturing costs.
B. selling price. D. unit production.
10. A criticism of variable costing for managerial accounting purposes is that it
A. is not acceptable for product line segmented reporting.
B. does not reflect cost-volume-profit relationships.
C. overstates inventories.
D. might encourage managers to emphasize the short term at the expense of the long term.
11. All of the following are names for the product costing method in which both fixed and variable
costs are included in overhead rates, except:
A. absorption costing C. direct costing
B. conventional costing D. full costing
12. Under the variable-costing concept, unit product cost would most likely be increased by
A. A decrease in the remaining useful life of factory machinery depreciated on the units-of-
production method.
B. A decrease in the number of units produced.
C. An increase in the remaining useful life of factory machinery depreciated on the sum-of-
the-year’s digits method.
D. An increase in the commission paid to salesman for each unit sold.
13. Under absorption costing, fixed manufacturing overhead could be found in all of the following
except the
A. work-in-process account. C. Cost of Goods Sold.
B. finished goods inventory account. D. period costs.
14. If unit costs remain unchanged and sales volume and sales price per unit both increase from the
preceding period when operating profits were earned, operating profits must
A. Increase under the absorption C. Decrease under the absorption costing
costing method. method.
B. Increase under the variable costing D. Decrease under the variable costing method
method.
15. When comparing absorption costing with variable costing, which of the following statements is not
true?
A. Absorption costing enables managers to increase operating profits in the short run by
increasing inventories.
B. When sales volume is more than production volume, variable costing will result in higher
operating profit.
C. A manager who is evaluated based on variable costing operating profit would be tempted to
increase production at the end of a period in order to get a more favorable review.
D. Under absorption costing, operating profit is a function of both sales volume and production
volume.
16. Jansen, Inc. pays bonuses to its managers based on operating income. The company uses
absorption costing, and overhead is applied on the basis of direct labor hours. To increase bonuses,
Jansen’s managers may do all of the following except
A. Produce those products requiring the most direct labor.
B. Defer expenses such as maintenance to a future period.
C. Increase production schedules independent of customer demands.
D. Decrease production of those items requiring the most direct labor.
17. A firm presently has total sales of $100,000. If its sales rise, its
A. net income based on variable costing will go up more than its net income based on
absorption costing.
B. net income based on absorption costing will go up more than its net income based on
variable costing.
C. fixed costs will also rise.
D. per unit variable costs will rise.
18. Both Company Y and Company Z produce similar products that need negligible distribution costs.
Their assets operation and accounting are very similar in all respects except that Company Y uses
direct costing and Company Z uses absorption costing.
A. Co. Y would report a higher inventory value than Co. Z for the years in which production
exceeds sales
B. Co. Y would report a higher inventory value than Co. Z for the years in which production
exceeds the normal or practical capacity
C. Co. Z would report a higher inventory value than Co. Y for the years in which production
exceeds sales
D. Co. Z would report a higher net income than Co. Y for the years in which production equals
sales
19. Which of the following statements is true for a firm that uses variable costing?
A. The cost of a unit of product changes because of changes in number of units manufactured.
B. Profits fluctuate with sales.
C. An idle facility variation is calculated.
D. Product costs include variable administrative costs.
21. A company’s net income recently increased by 30% while its inventory increased to equal a full
year’s sales requirements. Which of the following accounting methods would be most likely to
produce the favorable income results?
A. Absorption costing. C. Variable costing.
B. Direct costing. D. Standard direct costing.
22. Unabsorbed fixed overhead costs in an absorption costing system are
A. fixed manufacturing costs not allocated to units produced.
B. variable overhead costs not allocated to units produced.
C. excess variable overhead costs.
D. costs that cannot be controlled.
23. When a firm prepares financial reports by using absorption costing
A. Profits will always increase with increases in sales.
B. Profits may decrease with increased sales even if there is no change in selling prices and
costs.
C. Decreased output and constant sales result in increased profits.
D. Profits will always decrease with decreases in sales.
24. Variable costing and absorption costing will show the same incomes when there are no
A. beginning inventories. C. variable costs.
B. ending inventories. D. beg and ending inventories.
25. Absorption costing differs from variable costing in that
A. standards can be used with absorption costing, but not with variable costing.
B. absorption costing inventories are more correctly valued.
C. production influences income under absorption costing, but not under variable costing.
D. companies using absorption costing have lower fixed costs.

Problem Solving
1. MNO Products, Inc. planned and actually manufactured 200,000 units of its single product in 2000,
its first year of operations. Variable manufacturing costs were P30 per unit of product. Planned and
actual fixed manufacturing costs were P600,000, and marketing and administrative costs totaled
P400,000 in 2000. MNO sold 120,000 units of product in 2000 at a selling price of P40 per unit. What
is the cost of the ending inventory assuming variable costing is used?
A. P2,400,000 C. P2,250,000
B. P2,750,000 D. P2,640,000
2. West Co.’s 1988 manufacturing costs were as follows:
Direct materials and direct labor $700,000
Other variable manufacturing costs 100,000
Dep of factory bldg and mfg equip 80,000
Other fixed manufacturing overhead 18,000
What amount should be considered product cost for external reporting purposes?
A. $700,000 C. $880,000
B. $800,000 D. $898,000
3. At the end of Killo Co.’s first year of operations, 1,000 units of inventory remained on hand.
Variable and fixed manufacturing cost per unit were $90 and $20, respectively. If Killo uses
absorption costing rather than direct (variable) costing, the result would be a higher pretax income of
A. $20,000. C. $0.
B. $70,000 D. $90,000.
4. Coomber Industries manufactures a single product using standard costing. Variable production
costs are $13 and fixed production costs are $125,000. Coomber uses a normal activity of 12,500
units to set its standard costs. Coomber began the year with 1,000 units in inventory, produced
11,000 units, and sold 11,500 units. The standard cost of goods sold under absorption costing would
be
A. $115,000 C. $253,000
B. $149,500 D. $264,500
5. Fleet, Inc. manufactured 700 units of Product A, a new product, during the year. Product A’s
variable and fixed manufacturing costs per unit were $6.00 and $2.00 respectively. The inventory of
Product A on December 31, consisted of 100 units. There was no inventory of Product A on January 1.
What would be the change in the dollar amount of inventory on December 31 if variable costing were
used instead of absorption costing?
A. $800 decrease. C. $0
B. $200 decrease. D. $200 increase.
6. GHI Company had P100,000 income using absorption costing. GHI has no variable manufacturing
costs. Beginning inventory was P5,000 and ending inventory was P12,000. What is the income under
variable costing?
A. P100,000. C. P88,000
B. P107,000 D. P93,000
7. A company has the following cost data:
Fixed manufacturing costs $2,000
Fixed selling, general, and administrative costs 1,000
Variable selling costs per unit sold 1
Variable manufacturing costs per unit 2
Beginning inventory 0 units
Production 100 units
Sales 90units at $40 per unit
Variable and absorption-cost net incomes are:
A. $320 variable, $520 absorption C. $330 variable, $530 absorption
B. $520 variable, $320 absorption D. $530 variable, $330 absorption
8. A company manufactures 50,000 units of a product and sells 40,000 units. Total manufacturing
cost per unit is $50 (variable manufacturing cost, $10; fixed manufacturing cost, $40). Assuming no
beginning inventory, the effect on net income if absorption costing is used instead of variable costing
is that:
A. net income is $400,000 lower C. net income is $400,000 higher
B. net income is the same D. net income is $200,000 higher
9. A company had an income of P50,000 using direct costing for a given month. Beginning and ending
inventories for the month are 13,000 units and 18,000 units, respectively. Ignoring income tax, if the
fixed overhead application rate was P2 per unit, what was the income using absorption costing?
A. P40,000 C. P60,000
B. P50,000 D. P70,000

10. In the ABC Company, sales are P800,000, cost of goods under absorption costing is P600,000, and
total operating expenses are P120,000. If cost of goods sold is 70% variable and total operating
expenses are 60% fixed, what is the contribution margin under variable costing?
A. P332,000.
B. P308,000.
C. P260,000.
D. P380,000.
- End –