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Absorption and Variable Costing

This document compares absorption costing and variable costing. Absorption costing treats all manufacturing costs as product costs, including both fixed and variable overhead. Variable costing only includes variable manufacturing costs as product costs and treats fixed costs as period costs. Variable costing results in lower inventory costs and higher net operating income compared to absorption costing. While variable costing provides useful information for decision making, it violates the matching principle and may understate inventory costs.

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409 views11 pages

Absorption and Variable Costing

This document compares absorption costing and variable costing. Absorption costing treats all manufacturing costs as product costs, including both fixed and variable overhead. Variable costing only includes variable manufacturing costs as product costs and treats fixed costs as period costs. Variable costing results in lower inventory costs and higher net operating income compared to absorption costing. While variable costing provides useful information for decision making, it violates the matching principle and may understate inventory costs.

Uploaded by

alliahnah
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Absorption and Variable

Costing
AE117
Absorption Costing
• Treats all manufacturing costs, whether fixed or variable, as product
or inventoriable costs
• Unit cost consists of direct materials, direct labor, and both fixed and
variable factory overhead
• Referred to as full cost, traditional, conventional or normal costing
• GAAP
Variable Costing
• Method of recording and reporting costs which regards only the variable
manufacturing costs as product costs
• Fixed manufacturing costs are treated as period costs
• The proponents of this costing method maintain that the fixed portion of
the factory overhead is more closely related to the capacity to produce
rather than the production of specific units and thus should be charged in
the period incurred
• Uses the contribution margin approach
• Also known as direct costing or marginal costing
• Not GAAP
Variable Costing Vs. Absorption Costing
• As to treatment of operating costs
Variable Costing Vs. Absorption Costing
• As to net operating income
Variable Costing Vs. Absorption Costing
• As to inventory costing
• Absorption costing inventories include both fixed and variable overhead
• Variable costing inventories include variable overhead only
• The peso amount of inventories under variable costing is always less than the
value of inventories under absorption costing
Variable Costing Vs. Absorption Costing
• As to income statement
• Absorption costing – distinguishes between production and other costs.
• Variable costing – distinguishes between variable and fixed costs
Variable Costing Vs. Absorption Costing
• As to theoretical basis
• Advocates of variable costing argue that fixed manufacturing costs are
incurred in order to have the capacity to produce output in a given period.
These costs are incurred whether or not the capacity is actually used to make
output. Thus, FFOH, having no future service potential, should be charged
against the period
• Advocates of absorption costing believe that all manufacturing costs, both
variable and fixed are essential to the production process and should not be
ignored in the determination of product costs
Reconciliation of Net Income under
Absorption and Variable Costing
Advantages of Variable Costing
• Reports are simpler and more understandable
• Data needed for BEP and CVP analysis are readily available
• More compatible with standard cost accounting system
• Problems involved in allocating fixed costs are eliminated
• Provides useful information for decision like pricing, elimination of a
product line, and other decision making problems encountered by the
management
• Profit for the period is not affected by changes in inventories
• Net operating income is closer to net cash flow
• The impact of fixed costs on profits is emphasized
• Makes it easier to estimate the profitability of products, customers and
segments of the business
Disadvantages of Variable Costing
• Separation of costs into fixed and variable might be difficult
• Management decisions, like product pricing, may require the
knowledge of the total product cost, including fixed factory overhead
• The matching principle is violated
• Cost of inventory is understated because of the exclusion of fixed
overhead from the product costs which affects working capital,
current ratio, and quick ratio, which may weaken the financial
position of the business

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