The document discusses the advantages of the contribution approach and compares absorption costing and variable costing. It notes that the contribution approach is easy for management to understand, is consistent with other analyses, and emphasizes the impact of fixed costs on profits. It explains that absorption costing requires allocating all manufacturing costs to products, while variable costing treats some costs like overhead as fixed costs not directly assigned to products. Absorption costing product costs can be misleading for decision making.

1. Advantages of the
Contribution Approach
Advantages
Management finds it
easy to understand.
Consistent with
CVP analysis.
Net operating income
is closer to
net cash flow.
Profit is not affected by
changes in inventories.
Consistent with standard
costs and flexible budgeting.
Impact of fixed
costs on profits
emphasized.
Easier to estimate profitability
of products and segments.

2. Fixed costs are
not really the costs
of any particular
product.
Variable
Costing
Variable versus
Absorption Costing
Absorption
Costing
All manufacturingAll manufacturing
costs must be assignedcosts must be assigned
to products to properlyto products to properly
match revenues andmatch revenues and
costs.costs.

3. Absorption
Costing
These are capacity
costs and will be
incurred even if nothing
is produced.
Variable versus
Absorption Costing
Variable
Costing
Depreciation,
taxes, insurance and
salaries are just as
essential to products
as variable costs.

4. Variable
Costing
Absorption
costing product costs
are misleading for
decision making.
They are the
numbers that
appear on our
external
reports.
Absorption
Costing
Variable versus
Absorption Costing

5. Note on the
Effects of Volume
Variable cost $10
Fixed manufacturing overhead $100,000
Units sold 10,000
Units
Produced
Total Variable
Cost
Fixed
Manufacturing
Overhead
Total
Manufacturing
Cost
Average
Manufacturing
Cost
Cost of
Goods Sold
10,000 $100,000 $100,000 $200,000 20.00$ 200,000$
12,000 $120,000 $100,000 $220,000 18.33$ 183,333$
14,000 $140,000 $100,000 $240,000 17.14$ 171,429$
16,000 $160,000 $100,000 $260,000 16.25$ 162,500$
18,000 $180,000 $100,000 $280,000 15.56$ 155,556$
20,000 $200,000 $100,000 $300,000 15.00$ 150,000$
Absorption Costing
Cost of goods sold decreases because production
exceeds sales, leaving a portion of fixed
manufacturing costs in inventory.

6. Note on the
Effects of Volume
COGS for 10,000 units
$100,000
$150,000
$200,000
10,000
14,000
18,000
22,000
26,000
30,000
34,000Number of units produced
COGS
Absorption Costing
Cost of goods sold decreases because production
exceeds sales, leaving a portion of fixed
manufacturing costs in inventory.

7. 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.