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1. Variable Costing:
A Tool for Management
Chapter
5

2. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Absorption
Costing
Variable
Costing
Direct materials
Direct labor Product costs
Product costs Variable mfg. overhead
Fixed mfg. overhead
Period costs
Period costs Selling & admin. exp.
Overview of Absorption and
Variable Costing

3. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Harvey Co. memproduksi satu
produk jadi, berikut ini informasi :
Number of units produced annually 25,000
Variable costs per unit:
Direct materials, direct labor,
and variable mfg. overhead 10$
Selling & administrative expenses 3$
Fixed costs per year:
Manufacturing overhead 150,000$
Selling & administrative expenses 100,000$
Penghitungan Biaya per Unit

4. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Unit product cost is determined as follows:
Selling and administrative expenses are
always treated as period expenses and
deducted from revenue.
Absorption
Costing
Variable
Costing
Direct materials, direct labor,
and variable mfg. overhead 10$ 10$
Fixed mfg. overhead
($150,000 ÷ 25,000 units) 6 -
Unit product cost 16$ 10$
Penghitungan Biaya per Unit

5. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Absorption Costing
Sales (20,000 × $30) 600,000$
Less cost of goods sold:
Beginning inventory -$
Add COGM (25,000 × $16) 400,000
Goods available for sale 400,000
Ending inventory (5,000 × $16) 80,000 320,000
Gross margin 280,000
Less selling & admin. exp.
Variable
Fixed
Net income
Harvey Co. had no beginning inventory, produced
25,000 units and sold 20,000 units this year.
Income Comparison of Absorption
and Variable Costing

6. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Harvey Co. had no beginning inventory, produced
25,000 units and sold 20,000 units this year.
Absorption Costing
Sales (20,000 × $30) 600,000$
Less cost of goods sold:
Beginning inventory -$
Add COGM (25,000 × $16) 400,000
Goods available for sale 400,000
Ending inventory (5,000 × $16) 80,000 320,000
Gross margin 280,000
Less selling & admin. exp.
Variable (20,000 × $3) 60,000$
Fixed 100,000 160,000
Net income 120,000$
Income Comparison of Absorption
and Variable Costing

7. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Variable Costing
Sales (20,000 × $30) 600,000$
Less variable expenses:
Beginning inventory -$
Add COGM (25,000 × $10) 250,000
Goods available for sale 250,000
Ending inventory (5,000 × $10) 50,000
Variable cost of goods sold 200,000
Variable selling & administrative
expenses (20,000 × $3) 60,000 260,000
Contribution margin 340,000
Less fixed expenses:
Manufacturing overhead 150,000$
Selling & administrative expenses 100,000 250,000
Net income 90,000$
Now let’s look at variable costing by Harvey Co.
Income Comparison of Absorption
and Variable Costing
Variable
costs
only.
All fixed
manufacturing
overhead is
expensed.

8. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Cost of
Goods
Sold
Ending
Inventory
Period
Expense Total
Absorption costing
Variable mfg. costs 200,000$ 50,000$
Fixed mfg. costs 120,000 30,000
320,000$ 80,000$
Variable costing
Variable mfg. costs 200,000$ 50,000$
Fixed mfg. costs - -
200,000$ 50,000$
Let’s compare the methods.
Income Comparison of Absorption
and Variable Costing

9. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Cost of
Goods
Sold
Ending
Inventory
Period
Expense Total
Absorption costing
Variable mfg. costs 200,000$ 50,000$ -$ 250,000$
Fixed mfg. costs 120,000 30,000 - 150,000
320,000$ 80,000$ -$ 400,000$
Variable costing
Variable mfg. costs 200,000$ 50,000$ -$ 250,000$
Fixed mfg. costs - - 150,000 150,000
200,000$ 50,000$ 150,000$ 400,000$
Let’s compare the methods.
Income Comparison of Absorption
and Variable Costing

10. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Reconciliation
Variable costing net income 90,000$
Add: Fixed mfg. overhead costs
deferred in inventory
(5,000 units × $6 per unit) 30,000
Absorption costing net income 120,000$
Fixed mfg. overhead $150,000
Units produced 25,000
= = $6.00 per unit
We can reconcile the difference between
absorption and variable income as follows:

11. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Extending the Example
Let’s look at the
second year
of operations
for Harvey
Company.

12. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Harvey Co. Year 2
In its second year of operations, Harvey Co.
started with an inventory of 5,000 units,
produced 25,000 units and sold 30,000 units.
Number of units produced annually 25,000
Variable costs per unit:
Direct materials, direct labor
variable mfg. overhead 10$
Selling & administrative
expenses 3$
Fixed costs per year:
Manufacturing overhead 150,000$
Selling & administrative
expenses 100,000$

13. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Harvey Co. Year 2
Unit product cost is determined as follows:
No change in Harvey’s
cost structure.
Absorption
Costing
Variable
Costing
Direct materials, direct labor,
and variable mfg. overhead 10$ 10$
Fixed mfg. overhead
($150,000 ÷ 25,000 units) 6 -
Unit product cost 6$ 10$

14. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Harvey Co. Year 2
Now let’s look at Harvey’s income statement
assuming absorption costing is used.

15. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Absorption Costing
Sales (30,000 × $30) 900,000$
Less cost of goods sold:
Beg. inventory (5,000 × $16) 80,000$
Add COGM (25,000 × $16) 400,000
Goods available for sale 480,000
Ending inventory - 480,000
Gross margin 420,000
Less selling & admin. exp.
Variable (30,000 × $3) 90,000$
Fixed 100,000 190,000
Net income 230,000$
Harvey Co. Year 2
These are the 25,000 units
produced in the current period.

16. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Harvey Co. Year 2
Next, we’ll look at Harvey’s income statement
assuming is used.

17. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Variable Costing
Sales (30,000 × $30) 900,000$
Less variable expenses:
Beg. inventory (5,000 × $10) 50,000$
Add COGM (25,000 × $10) 250,000
Goods available for sale 300,000
Ending inventory -
Variable cost of goods sold 300,000
Variable selling & administrative
expenses (30,000 × $3) 90,000 390,000
Contribution margin 510,000
Less fixed expenses:
Manufacturing overhead 150,000$
Selling & administrative expenses 100,000 250,000
Net income 260,000$
Harvey Co. Year 2
Variable
costs
only.
All fixed
manufacturing
overhead is
expensed.

18. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Summary
Income Comparison
Costing Method 1st Period 2nd Period Total
Absorption 120,000$ 230,000$ 350,000$
Variable 90,000 260,000 350,000

19. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Summary
Relation between Effect Relation between
production on variable and
Year and sales iniventory absorption income
Inventory Absorption
1st Production > Sales increases by >
year 25,000 > 20,000 5,000 units. Variable
Inventory Absorption
2nd Production < Sales decreases <
year 25,000 < 30,000 to zero. Variable
Both Absorption
years Production = Sales No change =
combined 50,000 = 50,000 Variable

20. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Advantages of the Contribution
Approach
Advantages
Management finds it
easy to understand.
Consistent with
CVP analysis.
Net income is closer
to net cash flow.
Profit is not affected by
changes in inventories.
Impact of fixed
costs on profits
emphasized.
Consistent with standard
costs and flexible budgeting.
Easier to estimate profitability
of products and segments.

21. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
End of Chapter 7

22. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Variable versus Absorption Costing
Fixed costs are
not really the costs
of any particular
product.
All manufacturing costs
must be assigned to
products to properly
match revenues and costs.
Absorption
Costing
Variable
Costing

23. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Variable versus Absorption Costing
Depreciation, taxes,
insurance and salaries
are just as essential to
products as variable costs.
Absorption
Costing
Variable
Costing
These are capacity
costs and will be
incurred if nothing
is produced.

24. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
I guess we won’t be
solving this controversy
today!
Variable versus Absorption Costing

25. © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
Impact of JIT Inventory Methods
In a JIT inventory system . . .
Production
tends to equal
sales . . .
So, the difference between variable and
absorption income tends to disappear.