H104
MANAGEMENT ACCOUNTING
ABSORPTION, VARIABLE AND THROUGHPUT COSTING
Absorption costing – a costing method that includes all manufacturing costs (direct materials, direct
labor, variable and fixed factory overhead) in the cost of a unit of product. It treats fixed factory
overhead as a product cost. Absorption costing is also known as full costing.
Variable costing – a 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 factory overhead as a period cost. Variable costing is also called direct costing.
Throughput costing – a costing method that includes only the direct costs (materials) in the cost of a
unit of product. It treats conversion costs whether variable or fixed as period cost.
Absorption vs. Variable Costing
Absorption costing Variable costing
All manufacturing costs – variable Fixed factory overhead costs are incurred in
and fixed – are necessary order to have the capacity to produce units
ingredients for production to take in a given period. These costs are incurred
Rationale place and should not be ignored in whether the capacity is used to make output.
determining product cost. These costs have no future service potential
and should be charged against the period
and not included in the product cost.
Consistent with accounting This violates the ‘matching principle’
standards. This method is (accounting principle that calls for the
acceptable for financial reporting recognition of expense by matching it with
Acceptability
and tax purposes. the related revenue in the same accounting
period). This is not acceptable for financial
reporting and tax purposes.
Fixed factory overhead is Fixed factory overhead is treated as a period
considered as a product cost. The cost. The peso amount of inventory under
Inventory peso amount of inventory under variable costing is always lesser than that of
absorption costing is always greater absorption costing.
than that of variable costing.
Distinguishes between production Distinguishes between variable and fixed
and other costs. Production costs costs. All variable costs are first deducted
Income pertaining to sold units are first from revenue to arrive at the contribution
statement deducted from sales to arrive at margin, and then fixed costs are deducted to
gross profit, and then other costs are obtain profit.
deducted to obtain net income.
Variable costing income may differ from absorption costing income because of the
Income difference in the amount of fixed factory overhead recognized as expense during
computation an accounting period. This is caused by the difference between production and
sales volume.
Why variable costing?
Advantages Disadvantages
Reports are simpler and more understandable Not in accordance with GAAP; hence, it is not
acceptable for external reporting
Problems involved in allocating fixed costs are Segregation of costs into fixed and variable might
eliminated be difficult
Data needed for break-even and CPV analyses The matching principle is violated. It excludes
are readily available fixed factory overhead from product costs and
charges the same as period costs regardless of
production and sales
More compatible with the standard cost Inventory costs and other related accounts, such
accounting system and provides information for as working capital, current ratio, and acid test
pricing decisions and other decision-making ratio are understated because of the exclusion of
problems encountered. fixed factory overhead
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Reconciliation of income under absorption and variable costing
• Main reason for the difference of income between the two methods: TIMING DIFFERENCE, i.e.
when to recognize fixed factory overhead as an expense (one treats it as a product cost, i.e.
expensed when the product is sold and the other treats it as a period cost, i.e. expensed
during the period incurred).
• The relationship between production and sales generally indicate the following income
patterns:
1. When production is equal to sales, there is no change in inventory. Fixed factory overhead
under absorption costing is equal to the fixed factory overhead under variable costing.
Thus, income in both methods are the same.
2. When production is greater than sales, there is an increase in inventory. Fixed factory
overhead expensed under absorption costing is less than that under variable costing. Thus,
absorption income is greater than variable income.
3. When production is less than sales, there is a decrease in inventory. Fixed factory overhead
expensed under absorption costing is greater than that of variable costing. Thus,
absorption income is less than variable income.
Summary:
Production > Sales Absorption income > Variable income
Production < Sales Absorption income < Variable income
Production = Sales Absorption income = Variable income
THEORIES
1. In a recent period, Marvel Co. incurred $20,000 of fixed manufacturing overhead and
deducted $30,000 of fixed manufacturing overhead. Marvel Co. must be using
a. absorption costing.
b. variable costing.
c. direct costing.
d. standard costing.
2. If a firm produces more units than it sells, absorption costing, relative to variable costing, will
result in
a. higher income and assets.
b. higher income but lower assets.
c. lower income but higher assets.
d. lower income and assets.
3. Under absorption costing, fixed manufacturing overhead could be found in all of the following
except the
a. work-in-process account.
b. finished goods inventory account.
c. Cost of Goods Sold.
d. period costs.
4. If a firm uses absorption costing, fixed manufacturing overhead will be included
a. only on the balance sheet.
b. only on the income statement.
c. on both the balance sheet and income statement.
d. on neither the balance sheet nor income statement.
5. Under absorption costing, if sales remain constant from period 1 to period 2, the company will
report a larger income in period 2 when
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a. period 2 production exceeds period 1 production.
b. period 1 production exceeds period 2 production.
c. variable production costs are larger in period 2 than period 1.
d. fixed production costs are larger in period 2 than period 1.
6. The FASB requires which of the following to be used in preparation of external financial
statements?
a. variable costing
b. standard costing
c. activity-based costing
d. absorption costing
7. An ending inventory valuation on an absorption costing balance sheet would
a. sometimes be less than the ending inventory valuation under variable costing.
b. always be less than the ending inventory valuation under variable costing.
c. always be the same as the ending inventory valuation under variable costing.
d. always be greater than or equal to the ending inventory valuation under variable
costing.
8. Absorption costing differs from variable costing in all of the following except
a. treatment of fixed manufacturing overhead.
b. treatment of variable production costs.
c. acceptability for external reporting.
d. arrangement of the income statement.
9. Profit under absorption costing may differ from profit determined under variable costing. How
is this difference calculated?
a. Change in the quantity of all units in inventory times the relevant fixed costs per unit.
b. Change in the quantity of all units produced times the relevant fixed costs per unit.
c. Change in the quantity of all units in inventory times the relevant variable cost per unit.
d. Change in the quantity of all units produced times the relevant variable cost per unit.
10. What factor, related to manufacturing costs, causes the difference in net earnings computed
using absorption costing and net earnings computed using variable costing?
a. Absorption costing considers all costs in the determination of net earnings, whereas
variable costing considers fixed costs to be period costs.
b. Absorption costing allocates fixed overhead costs between cost of goods sold and
inventories, and variable costing considers all fixed costs to be period costs.
c. Absorption costing “inventories” all direct costs, but variable costing considers direct
costs to be period costs.
d. Absorption costing “inventories” all fixed costs for the period in ending finished goods
inventory, but variable costing expenses all fixed costs.
11. Under variable costing, which of the following are costs that can be inventoried?
a. variable selling and administrative expense
b. variable manufacturing overhead
c. fixed manufacturing overhead
d. fixed selling and administrative expense
12. 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.
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13. How will a favorable volume variance affect net income under each of the following
methods?
Absorption Variable
a. reduce no effect
b. reduce increase
c. increase no effect
d. increase reduce
14. A basic tenet of variable costing is that period costs should be currently expensed. What is the
rationale behind this procedure?
a. Period costs are uncontrollable and should not be charged to a specific product.
b. Period costs are generally immaterial in amount and the cost of assigning the amounts
to specific products would outweigh the benefits.
c. Allocation of period costs is arbitrary at best and could lead to erroneous decision by
management.
d. Because period costs will occur whether production occurs, it is improper to allocate
these costs to production and defer a current cost of doing business.
15. Which of the following is an argument against the use of direct (variable) costing?
a. Absorption costing overstates the balance sheet value of inventories.
b. Variable factory overhead is a period cost.
c. Fixed manufacturing overhead is difficult to allocate properly.
d. Fixed manufacturing overhead is necessary for the production of a product.
16. 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.
17. Gomez's inventory increased during the year. On the basis of this information, income
reported under absorption costing:
a. will be the same as that reported under variable costing.
b. will be higher than that reported under variable costing.
c. will be lower than that reported under variable costing.
d. will differ from that reported under variable costing, the direction of which cannot be
determined from the information given.
e. will be less than that reported in the previous period.
18. A criticism of absorption 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.
19. Variable costing and absorption costing will show the same incomes when there are no
a. beginning inventories.
b. ending inventories.
c. variable costs.
d. beginning and ending inventories.
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20. The use of variable costing requires knowing
a. the contribution margin and break-even point for each product.
b. the variable and fixed components of production cost.
c. controllable and noncontrollable components of all costs.
d. the number of units of each product produced during the period.
21. Under throughput costing, the cost of a unit typically includes:
a. selling costs.
b. fixed manufacturing overhead.
c. the direct costs incurred whenever a unit is manufactured.
d. administrative costs.
e. all of the above.
22. Orion's management recently committed to incurring direct labor and all manufacturing
overhead charges regardless of the number of units produced. Under throughput costing, the
company's cost of goods sold would include charges for:
a. selling and administrative costs.
b. direct materials.
c. direct labor and manufacturing overhead.
d. direct materials, direct labor, and manufacturing overhead.
e. direct materials, direct labor, manufacturing overhead, and selling and administrative
costs.
23. The fixed-overhead volume variance under variable costing:
a. coincides with the fixed manufacturing overhead that was applied to production.
b. is deducted on the income statement.
c. does not exist.
d. will equal the fixed-overhead budget variance.
e. must be unfavorable.
24. Which of the following differs between absorption costing and variable costing?
a. The number of units produced.
b. The fixed-overhead volume variance.
c. Sales revenues.
d. The treatment of variable manufacturing overhead.
e. Income tax rates.
25. An unfavorable volume variance means that
a. cost control was probably poor.
b. absorption costing income is lower than variable costing income.
c. actual output was less than the level used to set the standard fixed cost.
d. actual output was more than the level used to set the standard fixed cost.
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PROBLEMS
Problem 1 (Absorption costing / full costing income statement vs. Variable costing income
statement). At the end of ACOSTA Corp’s first year of operations, it was able to produce a total of 10
000 gallons of Chemical X, a highly poisonous liquid. Out of this production, only 8 000 gallons were
sold. The ingredients to produce each gallon of Chemical X costs P2.50 per gallon. Direct labor per
gallon costs P1.50. Manufacturing overhead per unit, variable and fixed are P0.50 and P2.00
respectively. Variable selling expense per unit is at P0.40. Fixed expenses total P6 000 for the year
ended. Sales price per gallon, is P10.00.
1. Compute for the net income under Absorption and Variable Costing, respectively.
a. 18,800; 14,800
b. 16,200; 13,600
c. 15,800; 12,300
d. 18,600; 14,600
2. Using the same facts, except that this time, assume 10 000 gallons of Chemical X were sold,
compute the net income under both absorption costing and variable costing, respectively.
a. 24,300; 24,300
b. 25,000; 25,000
c. 22,500; 22,500
d. 25,000; 24,100
3. Using the same facts, except that this time, assume 11,000 gallons of Chemical X were sold,
compute the net income under both absorption costing and variable costing, respectively.
a. 28,100; 30,100
b. 30,100; 28,100
c. 27,500; 25,600
d. 28,100; 26,500
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Problem 2 (Product costs and period costs, Roque). During January of the current year, ALINAB
Company produced and sold 1 000 units of Product A with costs as follows:
Materials P 6 000 6
Labor 3 000 3
Variable factory overhead 2 500 2.5
Fixed factory overhead 1 500 1.5
Total manufacturing costs P 13 000
Selling and administrative costs incurred during the month were:
Variable selling and administrative P 3 000
Fixed selling and administrative 2 000
P 5 000
Determine the following amounts:
4. Product costs per unit under absorption costing
a. P13.50
b. P11.50
c. P13.00
d. P14.50
5. Product costs per unit under variable costing
a. P13.00
b. P11.50
c. P13.50
d. P14.50
6. Cost of goods sold per unit
a. P13.00
b. P11.50
c. P13.50
d. P14.50
7. Variable costs per unit (which will be deducted form sales price in arriving at unit contribution
margin)
a. P13.00
b. P11.50
c. P13.50
d. P14.50
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Problem 3 (Variable costing ending inventory, BOBADILLA). The following information pertains to
ANGELES Corporation.
Beginning inventory 2 000 units
Ending inventory 5 000 units
Direct labor per unit P 10
Direct materials per unit 8
Variable overhead per unit 2
Fixed overhead per unit 5
Variable selling costs per unit 6
Fixed selling costs per unit 8
8. What is the value of ending inventory using the absorption costing method?
a. 135,000
b. 120,000
c. 125,000
d. 128,000
9. What is the value of ending inventory using the variable costing method?
a. 125,000
b. 100,000
c. 115,000
d. 105,000
10. What is the difference in amount of operating profit between absorption costing and variable
costing?
a. 25,000
b. 10,000
c. -0-
d. 15,000
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Problem 4 (Volume Variance). The following information pertains to ASIS Corp.
Sales price P200 Variable expense per unit 10
Variable production cost 120 Fixed expense 100,000
Fixed production overhead 20*
Beginning inventory 4 000 units
Normal capacity 20 000 units
*Fixed production overhead per unit is based on normal capacity
Under each scenario, compute for the profit under both full costing and direct costing, respectively.
11. Sales 22 000 units; Production 21 000 units
a. 1,020,000; 1,000,000
b. 1,040,000; 1,020,000
c. 1,020,000; 1,040,000
d. 1,000,000; 1,040,000
12. Sales 15 000 units; Production 18 000 units
a. 610,000; 550,000
b. 550,000; 610,000
c. 590,000; 550,000
d. 550,000; 550,000
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Problem 5 (Throughput costing). BERNABE Co. has the following standard costs associated with the
manufacture and sale of its products.
Direct materials P3.00 per u
Direct labor 2.50 per u
Variable manufacturing overhead 1.80 per u
Fixed manufacturing overhead 4.00 per u (based on est. of 50 000 units per year)
Variable expenses P0.25 per u
Fixed expenses P75 000 (total amount)
In Y1, 51 000 units were manufactured. Of these units, 48 000 were sold. Sales price is P25.00
13. How much is the std. production cost per unit for the current year under absorption costing?
14. How much is the std. production cost per unit for the current year under variable costing?
15. How much is the volume variance under absorption costing?
16. How much is the volume variance under variable costing?
17. How much is the std. production cost per unit for the current year under throughput costing?
18. How much is the operating income under variable costing?
19. How much is the operating income under absorption costing?
20. How much is the operating income under throughput costing?
a. -0-
b. P11.30
c. P12.30
d. P7.30
e. P6.30
f. P564,700
g. 526,000
h. P574,600
i. P549,700
j. P3.00
k. P3.50
l. P4,000
m. P5,000
n. P562,600
-END-
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