MANAGEMENT ADVISORY SERVICES

PRODUCT COSTING
ABSORPTION COSTING (also called full costing, conventional costing)

– costing method that includes all manufacturing costs (direct materials, direct labor, and both
variable and fixed manufacturing overhead) in the cost of a unit of product. It treats fixed
manufacturing overhead as a product cost.

VARIABLE COSTING (also called direct costing)

– costing method that includes only variable manufacturing costs (direct materials, direct labor,
and variable manufacturing overhead) in the cost of a unit of product. It treats fixed
manufacturing overhead as a period cost.

DISTINCTIONS BETWEEN PERIOD COSTS AND PRODUCT COSTS:

PERIOD COST PRODUCT COST

1. Refers to an item charged against 1. Refers to an item included in
current revenue on the basis of time product costing which is
period regardless of the difference apportioned between the sold and
between production and sales volume. unsold units.
2. Does not form part of the cost
of inventory. 2. The portion of the cost, which has
been allocated to the unsold units,
becomes part of the inventory.
3. Diminishes income for the current 3. Diminishes current income by that
period by its full amount. portion thereof identified with the sold
units only with the remainder being
deferred to the next accounting period
as part of the cost
of ending inventory.

PRINCIPAL DIFFERENCES BETWEEN VARIABLE AND CONVENTIONAL ABSORPTION COSTING:

ABSORPTION COSTING VARIABLE COSTING

Seldom segregates costs into Costs are segregated into variable
1. Cost segregation
variable and fixed costs and fixed
Cost of inventory includes all the Cost of inventory includes only
manufacturing costs: materials, the variable manufacturing
2. Cost of Inventory
labor, variable factory overhead, costs: materials, labor, and
and fixed factory overhead variable factory overhead
3. Treatment of
Fixed factory overhead is treated Fixed factory overhead is
fixed factory
as product cost. treated as period cost.
overhead

Distinguishes between variable

Distinguishes between production
4. Income and fixed costs.
and other costs.
statement

Net income between the two methods may differ from each other
because of the difference in the amount of fixed overhead costs
recognized as expense during an accounting period. This is due to
5. Net income variations between sales and production. In the long run, however,
both methods give substantially the same results since sales cannot
continuously exceed production, nor production can continually
exceed sales.

DIFFERENCE IN NET INCOME UNDER ABSORPTION AND VARIABLE COSTING:

Variable and absorption costing methods of accounting for fixed manufacturing overhead result in
different levels of net income in most cases. The differences are timing differences, i.e., when to
recognize the fixed manufacturing overhead as an expense. In variable costing, it is expensed during
the period when the fixed overhead is incurred, while in absorption costing, it is expensed in the
period when the units to which such fixed overhead has been related are sold.
Production Equals Sales:
When production is equal to sales, there is no change in inventory. Fixed overhead expensed under
absorption costing equals fixed overhead expensed under variable costing. Therefore, absorption
costing income equals variable costing income.

Production is Greater Than Sales

When production is greater than sales, there is an increase in inventory. Fixed overhead expensed
under absorption costing is less than fixed overhead expensed under variable costing. Therefore,
absorption income is greater than variable costing.

Production is Less Than Sales

When production is less than sales, there is decrease in inventory. Fixed overhead expensed under
absorption is greater than fixed overhead expensed under variable costing. Therefore, absorption
income is less than variable costing income.

ARGUMENTS FOR THE USE OF VARIABLE COSTING

1. Variable costing reports are simpler and more understandable.

2. Data needed for break-even and cost-volume-profit analyses are readily available.
3. The problems involved in allocating fixed costs are eliminated.
4. Variable costing is more compatible with the standard cost accounting system.
5. Variable costing reports provide useful information for pricing decisions and other decision-
making problems encountered by management.

ARGUMENTS AGAINST VARIABLE COSTING

1. Segregation of costs into fixed and variable might be difficult, particularly in the case of mixed
costs.
2. The matching principle is violated by using variable costing which excludes fixed overhead from
product costs and charges the same to period costs regardless of production and sales.
3. With variable costing, inventory costs and other related accounts, such as working capital,
current ratio, and acid-test ratio are understated because of the exclusion of fixed overhead in
the computation of product cost.

THROUGHPUT COSTING (or SUPERVARIABLE COSTING)

An extreme form of variable costing in which only direct material costs are included as
inventoriable costs. All other costs are costs of the period in which they are incurred.

Throughput margin = Revenue – Direct material cost of the goods sold

EXERCISES:

1. The following data relate to a company’s first year of operation, when 20,000 units were
produced and 18,000 units were sold.
Variable costs per unit:
Direct material ₱40
Direct labor 20
Variable overhead 14
Variable selling costs 12

Fixed costs:
Selling and administrative ₱750,000
Manufacturing 400,000

Selling price ₱160

REQUIRED:
1. Compute the product costs per unit under absorption and variable costing.
2. Compute the costs of ending inventory under absorption and variable costing.
3. Prepare income statements based on absorption and variable costing.
4. Explain the difference in income between the two costing methods.
5. Compute the throughput margin and income under throughput costing.

2. A company uses an absorption costing system based on standard costs. Following are some
data about the company’s operations in 2024:
 Selling price per unit ₱5
Total variable manufacturing costs per unit were ₱3 Total
budgeted and actual fixed manufacturing overhead costs ₱420,000 Fixed
manufacturing overhead ₱7 per machine hour
(₱420,000 ÷ 60,000 machine hours of denominator level)
Variable marketing and administrative costs, driven by units sold ₱1 per unit
Fixed marketing and administrative costs ₱120,000 Actual
variable manufacturing costs incurred in 2024 ₱1,600,000

Beginning inventory in 2024 30,000 units

Ending inventory 40,000 units
. Sales in 2024 540,000 units.

The same standard unit costs persisted throughout 2023 and 2024. The

standard production rate was 10 units per machine hour.

Required:
1. Prepare an income statement for 2024 assuming that all variances are written off directly at
year-end as an adjustment to Cost of Goods Sold.
2. The president has heard about variable costing. He asks you to recast the 2024 income
statement as it would appear under variable costing.
3. Explain the difference in operating income as calculated in requirements 1 and 2.