Variable Costing

(Supporters of it see FIXED MOH as

capacity cost and believe that it will be
incurred even if nothing is produced.)

(+):Management finds it easy to

understand
(+): Emphasizes contributions in shortrun pricing decisions supporters of it
think that VC method is a better basis
for pricing decisions as any price above
a products variable costs makes a
positive contribution to covering fixed
cost and profit
(+):Argue that fixed cost component of
a product has no future service
potential as fixed MOH are incurred
every period, regardless of production
levels, whereas variable costs incurred
to manufacture a product will not be
repeated.
(+): Easier to estimate profitability of
products and segments
(+): Profit for period not affected by
changes in inventories & changes in
FIXED MOH.
(+): Impact of fixed costs on profits
emphasized; as they treat fixed costs as
a lump sum, and its dollar amount
would not vary with the output/activity
level.
(+): Consistent with CVP analysis

Absorption costing
(Supporters of it see it as a cost
incurred due to production, hence treat
it on a per-unit basis and assign to
products to properly match revenues
and costs) in line with matching
principle; costs relating to units being
sold are recognized.

(+): Absorption-costing data used for

cost-based pricing decisions, as many
believe that it is a cost incurred and
excluding it will understate cost of
product
(Consistent with long run pricing
decisions that must cover full cost)
(+)Supporters of absorption costing feel
that inventory(an asset) should be
valued at its full cost of production, and
argue that these costs have future
service potential since the inventory
can be sold in the future to generate
sales revenue
(-): may result in wrong income being
presented to management.

(-): Inconsistent with CVP analysis due

to treatment of fixed costs on a per-unit
basis.
(+): External reporting and income tax
law
require absorption costing

(-): Inconsistent with external report

and income tax law requirements. GAAP
require income reporting be based on
absorption costing.
Evaluation of Variable Costing & Absorption costing

JIT Environment (Just-in-time)

Production tends to equal to sales under this environment and hence

has no impact on inventory methods.

All inventories are kept very low Finished goods inventories are
minimal
Difference between variable and absorption income tends to disappear

*Over a period of time, eventually when total production = total units sold
over whole period; income reported under both methods would be the
same.

Overapplied and Underapplied MOH summary

ABC 2-stage cost-assignment process

5-step strategy to eliminate non-value-added costs in both manufacturing

and service industry firms:
1) Identifying activities
Sieve out all organizations significant activities
2) Identify non-value-added activities
Use the follow 3 criteria as a guide to determine:
Is the activity necessary?
If is duplicate or nonessential operation, it is non-value-added
Is the activity efficiently performed?
(Compare the actual perf of the activity to a value-added baseline
established using budgets, targets or external benchmarks)
Is an activity sometimes value-added and sometimes non-value
added?
(For eg, necessary to move WIP units between production
operations, but unnecessary to move raw materials around while in
storage)
3) Understand activity linkages, root causes and triggers
Critical to understand the ways in which activities are linked together

Rework of defective products is a non-value-added activity

Rework is triggered by inspection
All 4 steps before inspection can be the root cause of rework
*Non-value-added cost=rework cost
4) Reporting non-value-added costs
Non-value added costs should be highlighted in activity center cost
reports
One approach that cost-management analysts find helpful in
identifying non-value-added activities is to categorize the ways in
which time is spent in a production process
Process time
Time during which a product is undergoing conversion activity.
Inspection time
Amount of time spent ensuring that the product is of high quality.
Move time (between operations)
Time spent moving raw materials, work in process, or finished
goods between operations.
Waiting time
Amount of time that raw materials or work in process spend waiting
for the next operation.
Storage time

Time during which materials, partially completed products, or

finished goods are held in stock before further processing or
shipment to customers.
Many companies implement Just-in-time (JIT) to reduce all the above time
taken.