Absorption and Variable Costing Absorption Variable Costing Costing Direct materials Direct labor Product costsProduct costs Variable mfg. overhead Fixed mfg. overhead Period costsPeriod costs Selling & Admin. exp. The difference between absorption and variable costing is the treatment of fixed manufacturing overhead.
Absorption and Variable Costing Mellon Co. produces a single product with the following information available: 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: Mfg. overhead $ 150,000 Selling & administrative expenses $ 100,000
Absorption and Variable CostingUnit product cost is determined as follows: Absorption Variable Costing CostingDirect materials, direct labor, andvariable mfg. overhead $ 10 $ 10Fixed mfg. overhead ($150,000 ÷ 25,000 units) 6 -Unit product cost $ 16 $ 10 Selling and administrative expenses are always treated as period expenses and deducted from revenue.
Absorption Costing Income StatementsMellon Co. had no beginning inventory, produced25,000 units and sold 20,000 units this year at $30 each. 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
Reconciling Income UnderAbsorption and Variable Costing We can reconcile the difference between absorption and variable net income as follows: 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 $ 120,000Fixed mfg. overhead $150,000 = = $6.00 per unit Units produced 25,000
Cost-Volume-Profit Analysis• CVP includes all fixed costs to compute breakeven. – Variable costing and CVP are consistent as both treat fixed costs as a lump sum.• Absorption costing defers fixed costs into inventory. – Absorption costing is inconsistent with CVP because absorption costing treats fixed costs on a per unit basis.
Evaluation of Variable Costing Management finds it Consistent with easy to understand. CVP analysis. Emphasizes contribution inAdvantages short-run pricing decisions. Impact of fixed Profit for period not costs on profits affected by changes emphasized. in fixed mfg. overhead.
Evaluation of Absorption Costing Fixed manufacturing overhead is treated the same as the other product costs, direct material and direct labor. Consistent with long-run Advantages pricing decisions that must cover full cost. External reporting and income tax law require absorption costing. costing
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.
Throughput Costing Unit-level Product spending for cost direct costs.Unit-level costs are incurred every time a unit ofproduct is manufactured and will not be incurred again until the next unit is manufactured.
Throughput Costing Example In an automated process direct material may be the only unit-level cost and so is the only product cost.All other manufacturing costs are expensed as period costs.Incentive to Average unit cost doesoverproduce not vary with changes is reduced in production levels. Advantages