STRATEGIC COST MANAGEMENT

PRODUCT COSTING

ILLUSTRATION 1
Online Corporation has the following data available:
Sales(P50 selling Prices) 500,000 Units:
Direct Materials 20,000 Beginning Inventory 2,000
Direct Labor 30,000 Production 12, 000
Overhead:
Variable 10,000
Fixed 60,000
Selling and Admin:
Variable 15,000
Fixed 25,000
1. Compute the unit cost under
a. Absorption costing
b. Variable costing
2. Compute for the net income under absorption costing
3. Compute Net income under variable costing
4. Reconciliation of net income
1.a UNIT COST UNDER ABSORPTION COSTING
Q:What are the components of product cost/ inventoriable cost under absorption costing?
A: Direct Materials, Direct Labor , Variable Overhead and Fixed Overhead
*Note : if the given is the total cost of each components(DM, DL, OH), divide the cost with the number of units produced
If the given is the cost of components(DM, DL, OH) per unit, add the cost per unit to get the total cost per unit
Computation
Direct Materials 20,000.00
Direct Labor 30,000.00
Variable overhead 10,000.00
Fixed Overhead 60,000.00
total Manufacturing cost 120,000.00
Divided by: Number of units produced 12,000.00
Unit cost under absorption costing 10.00
Alternative computation:
Components Total cost Units produced Cost per unit
Direct Materials 20,000.00 12,000 1.67
Direct Labor 30,000.00 12,000 2.50
Variable overhead 10,000.00 12,000 0.83
Fixed Overhead 60,000.00 12,000 5.00
TOTAL 120,000.00 10.00
1.b. UNIT COST UNDER VARIABLE COSTING
Q:What are the components of product cost/ inventoriable cost under VARIABLE costing?
A: Direct Materials, Direct Labor , Variable Overhead
Note: the process is same with Absorption costing except that the Fixed overhead is not considered as
product cost
Computation
Direct Materials 20,000.00
Direct Labor 30,000.00
Variable overhead 10,000.00
total Manufacturing cost 60,000.00
Divided by: Number of units produced 12,000.00
Unit cost under absorption costing 5.00

Alternative computation:
Components Total cost Units produced Cost per unit
Direct Materials 20,000.00 12,000 1.67
Direct Labor 30,000.00 12,000 2.50
Variable overhead 10,000.00 12,000 0.83
TOTAL 60,000.00 5.00
STRATEGIC COST MANAGEMENT
PRODUCT COSTING

2 Income statement under Absorption costing

Pro-forma Income statement under Absorption costing
Sales Pxx
Less: Cost of Sales/ product cost (xx)
Gross Profit xx
Less: Operating expense /Selling and Admin/ Period cost (xx)
Net Income xx

*Q: How to compute Cost of sales?

A: Multiply the number of units sold with the computed cost per unit in 1.a.

**Q: what are the components of Period cost?

A: All operating expense/ selling and Admin expense

Computation:
Sales 500,000.00
Less: Cost of Sales/ product cost (10000*10) 100,000.00
Gross Profit 400,000.00
Less: Operating expense /Selling and Admin/ Period cost
Variable 15,000.00
Fixed 25,000.00 40,000.00
Net Income 360,000.00

Alternative Computation:
Sales 500,000.00
Less: Cost of Sales/ product cost
Direct Materials (10,000*1.67) 16,700.00
Direct Labor (10,000*2.50) 25,000.00
Variable Overhead (10,000*0.83) 8,300.00
Fixed Overhead (10,000*5) 50,000.00 100,000.00
Gross Profit 400,000.00
Less: Operating expense /Selling and Admin/ Period cost
Variable 15,000.00
Fixed 25,000.00 40,000.00
Net Income 360,000.00

3.Income statement under variable costing

Pro-forma Income statement under variable costing
Sales Pxx
Less: Variable costs
Variable manufacturing cost xx
Variable selling and admin xx (xx)
Contribution Margin xx
Less: Fixed Costs
Fixed manufacturing cost xx
Firx selling and admin xx (xx)
Net Income xx

Q: Is Variable selling and admin cost inventoriable cost or part of product cost?
A: NO. Variable selling and admin expenses are deductible expense to get the contribution margin
but it is not part of product cost

Q: How much Fixed manufacturing cost are expensed under Variable costing?
A: All Fixed Manufacturing cost incurred during the period. No need to allocate depending on units sold
STRATEGIC COST MANAGEMENT
PRODUCT COSTING

Computation
Sales 500,000.00
Less: Variable costs
Variable manufacturing cost 50,000.00
Variable selling and admin 15,000.00 65,000.00
Contribution Margin 435,000.00
Less: Fixed Costs
Fixed manufacturing cost 60,000.00
Firx selling and admin 25,000.00 85,000.00
Net Income 350,000.00

Alternative Computation:
Sales 500,000.00
Less: Variable costs
Direct Materials (10,000*1.67) 16,700.00
Direct Labor (10,000*2.50) 25,000.00
Variable Overhead (10,000*0.83) 8,300.00
Variable selling and admin 15,000.00 65,000.00
Contribution Margin 435,000.00
Less: Fixed Costs
Fixed manufacturing cost 60,000.00
Firx selling and admin 25,000.00 85,000.00
Net Income 350,000.00

4. Reconciliation of Net income under Absorption costing and Net income under Variable costing
Q: How to get fixed manufactiuring overhead on ending/beginning inventory?
A: Multiply the cost number of units in ending or beginning inventory by the computed cost of
fixed manufacturing overhead (cost per unit) refer to 1.a.

Net income under absorption costing 360,000.00

Add: Fixed Manufacturing cost on Beginning Inventory
(2000*5) 10,000.00
Total 370,000.00
Less: Fixed Manufacturing cost on Ending Inventory (4000*5) 20,000.00
Net income under variable costing 350,000.00
STRATEGIC COST MANAGEMENT
PRODUCT COSTING

Illustration 2
Given:
Variable cost per unit:
Production:
Direct Materials P18
Direct Labor 7
Variable manufacturing overhead 2
Variable selling and admin 5

Fixed costs peryear

Fixed Manufacturing overhead 160,000.00
Fixed selling and administrative expense 110,000.00
During the year, the company prodcued 20,000 units and sold 16,000 units.
The selling price of the company's prodcuct is P50 per unit.

Required:
1. Compute the unit product cost under
a. Absorption costing
b. Variable costing

2. Prepared an income statement of the year using

a. Absorption costing
b. Variable costing

Solution:
1.a UNIT COST UNDER ABSORPTION COSTING 1.b. UNIT COST UNDER VARIABLE COSTING
Components Total cost Units produced Cost per unit Components Cost per unit
Direct Materials 18.00 Direct Materials 18.00
Direct Labor 7.00 Direct Labor 7.00
Variable overhead 2.00 Variable overhead 2.00
Fixed Overhead 160,000.00 20,000 8.00 TOTAL 27.00
TOTAL 160,000.00 35.00

2.a. Income statement under Absorption costing 2.b. .Income statement under variable costing
Sales 800,000.00 Sales 800,000.00
Less: Cost of Sales/ product cost Less: Variable costs
Direct Materials (16,000*18) 288,000.00 Direct Materials (16,000*18) 288,000.00
Direct Labor (16,000*7) 112,000.00 Direct Labor (16,000*7) 112,000.00
Variable Overhead (16,000*2) 32,000.00 Variable Overhead (16,000*2) 32,000.00
Fixed Overhead (16,000*8) 128,000.00 560,000.00 Variable (16,000*5) 80,000.00 512,000.00
Gross Profit 240,000.00 Contribution Margin 288,000.00
Less: Operating expense /Selling and Admin/ Period cost Less: Fixed Costs
Variable (16,000*5) 80,000.00 Fixed manufacturing cost 160,000.00
Fixed 110,000.00 190,000.00 Firx selling and admin 110,000.00 270,000.00
Net Income 50,000.00 Net Income 18,000.00

Reconciliation of net income

Net income under absorption costing 50,000.00
Add: Fixed Manufacturing cost on Beginning Inventory
0 -
Total 50,000.00
Less: Fixed Manufacturing cost on Ending
(4000*8)
Inventory 32,000.00
Net income under variable costing 18,000.00
STRATEGIC COST MANAGEMENT
PRODUCT COSTING

ILLUSTRATION 3

Q: Which costing method would result to a higher net income?

A: Depends on the level of sales and production
NET INCOME EXPENSE
AC VC AC VC
Sales = Production same same same same
Sales < Production Higher lower lower higher
Sales > Production lower higher higher lower

Use the data below to test the question given above:

Manufacturing costs:
Direct materials cost per unit P30
Direct labor cost per unit 14
variable manufacturing overhead cost per unit 4
Fixed manufacturing overhead P1,280,000

Marketing and Admin expenses

Variable Marketing and Admin cost per unit P4
Fixed Marketing and Admin P1,120,000

First assumption: Sales and production are on same level and no beginning inventory
Beginning inventory 0
Units produced 40,000
Units sold 40,000
Selling price per unit P120

Solution:
UNIT COST UNDER ABSORPTION COSTING 1.b. UNIT COST UNDER VARIABLE COSTING
Components Total cost Units produced Cost per unit Components Cost per unit
Direct Materials 30.00 Direct Materials 30.00
Direct Labor 14.00 Direct Labor 14.00
Variable overhead 4.00 Variable overhead 4.00
Fixed Overhead 1,280,000.00 40,000 32.00 TOTAL 48.00
TOTAL 1,280,000.00 80.00

Income statement under Absorption costing Income statement under variable costing
Sales (40,000*120) 4,800,000.00 Sales 4,800,000.00
Less: Cost of Sales/ product cost Less: Variable costs
Direct Materials (40,000*30) 1,200,000.00 Direct Materials (40,000*30)
1,200,000.00
Direct Labor (40,000*14) 560,000.00 Direct Labor (40,000*14) 560,000.00
Variable Overhead (40,000*4) 160,000.00 Variable Overhead (40,000*4)160,000.00
Fixed Overhead (40,000*32) 1,280,000.00 3,200,000.00 Variable (40,000*4) 160,000.00 2,080,000.00
Gross Profit 1,600,000.00 Contribution Margin 2,720,000.00
Less: Operating expense /Selling and Admin/ Period cost Less: Fixed Costs
Variable (40,000*4) 160,000.00 Fixed manufacturing cost
1,280,000.00
Fixed 1,120,000.00 1,280,000.00 Firx selling and admin 1,120,000.00 2,400,000.00
Net Income 320,000.00 Net Income 320,000.00
*Scenario number 1 must result to same amount of net income

Second assumption: Sales is less than production

Beginning inventory 0
Units produced 40,000
Units sold 36,000
Selling price per unit P120
STRATEGIC COST MANAGEMENT
PRODUCT COSTING

Income statement under Absorption costing Income statement under variable costing
Sales (36,000*120) 4,320,000.00 Sales 4,320,000.00
Less: Cost of Sales/ product cost Less: Variable costs
Direct Materials (36,000*30) 1,080,000.00 Direct Materials (36,000*30)
1,080,000.00
Direct Labor (36,000*14) 504,000.00 Direct Labor (36,000*14) 504,000.00
Variable Overhead (36,000*4) 144,000.00 Variable Overhead (36,000*4)144,000.00
Fixed Overhead (36,000*32) 1,152,000.00 2,880,000.00 Variable (36,000*4) 144,000.00 1,872,000.00
Gross Profit 1,440,000.00 Contribution Margin 2,448,000.00
Less: Operating expense /Selling and Admin/ Period cost Less: Fixed Costs
Variable (36,000*4) 144,000.00 Fixed manufacturing cost
1,280,000.00
Fixed 1,120,000.00 1,264,000.00 Firx selling and admin 1,120,000.00 2,400,000.00
Net Income 176,000.00 Net Income 48,000.00

Reconciliation of net income

Net income under absorption costing 176,000.00 *the Net income under Absorption costing is higher since
Add: Fixed Manufacturing cost on Beginning Inventory0 - portion of Fixed manufacturing overhead is capitalized to
Total 176,000.00 inventory while under variable costing all fixed
Less: Fixed Manufacturing cost on Ending
(4000*32)
Inventory 128,000.00 manufacturing are expensed outright
Net income under variable costing 48,000.00

Third assumption: Sales is greater than production

Beginning inventory 2,000

Units produced 40,000
Units sold 42,000
Selling price per unit P120
* assuming that the cost per unit of beginning inventory has the same unit cost

Income statement under Absorption costing Income statement under variable costing
Sales (42,000*120) 5,040,000.00 Sales 5,040,000.00
Less: Cost of Sales/ product cost Less: Variable costs
Direct Materials (42,000*30) 1,260,000.00 Direct Materials (42,000*30)
1,260,000.00
Direct Labor (42,000*14) 588,000.00 Direct Labor (42,000*14) 588,000.00
Variable Overhead (42,000*4) 168,000.00 Variable Overhead (42,000*4)168,000.00
Fixed Overhead (42,000*32) 1,344,000.00 3,360,000.00 Variable (42,000*4) 168,000.00 2,184,000.00
Gross Profit 1,680,000.00 Contribution Margin 2,856,000.00
Less: Operating expense /Selling and Admin/ Period cost Less: Fixed Costs
Variable (42,000*4) 168,000.00 Fixed manufacturing cost
1,280,000.00
Fixed 1,120,000.00 1,288,000.00 Firx selling and admin 1,120,000.00 2,400,000.00
Net Income 392,000.00 Net Income 456,000.00

64000
Reconciliation of net income
Net income under absorption costing 392,000.00
Add: Fixed Manufacturing cost on Beginning
(2000*32)
Inventory 64,000.00
Total 456,000.00
Less: Fixed Manufacturing cost on Ending Inventory -
Net income under variable costing 456,000.00

*Net income under varaible costing is higher since the fixed manufacturing overhead of beginning inventory is no longer deductible in the current period
and was expensed in previous period

Q: Is Which costing method has a bigger inventory cost?

A: Absorption costing because there is fixed manufacturing cost