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Variable costing:
Tool for management
2.
b.
Income statement
3.
4.
5.
6.
b.
Absorption costing
i.
ii.
iii.
iv.
Variable costing
i.
Only those manufacturing costs that vary with output are treated as
product costs
ii.
iii.
Fixed OH not treated as product cost, but like period cost, i.e., expensed
entirely each period and excluded from product costs
ii.
Product costs
Period costs
Variable
Costing
Direct materials
Direct labor
Variable manufacturing OH
overhead
Fixed manufacturing OH
overhead
Selling and administrative
expenses
Product costs
Period costs
25,000
$10
$3
Fixed OH
$150,000
$100,000
Absorption
Variable
Costing
Costing
$10
$10
6
$16
-0$10
S&A expenses are always treated as period costs; they are not treated as product costs under either
costing method.
320,000
250,000
Cost of
Ending
Goods Sold
Inventory
Absorption costing
Variable manufacturing costs
(20,000 x $10)
$200,000
(5,000 x $10)
$50,000
120,000
30,000
$320,000
$80,000
Variable costing
Variable manufacturing costs
(20,000 x $10)
$200,000
(5,000 x $10)
Total
$200,000
$50,000
$50,000
$90,000
30,000
$120,000
10
Questions:
i.
ii.
iii.
11
12
5,000
$5
$1
$15,000
$21,000
Variable
Costing
$5
$5
-0-
$5
Income statements using both costing methods over a three-year period are provided on the following transparency. (Note
the computation of the variable cost of goods sold on the variable costing income statements. The method used is simpler
than the method used in the previous example.)
Year 2
Year 3
5,000
5,000
5,000
4,000
5,000
6,000
-0-
Absorption costing
Sales (@ $15)
-040,000
8,000
-0-
-0-
40,000
8,000
28,000
42,000
48,000
-0-
13
Year 2
Year 3
5,000
5,000
5,000
4,000
5,000
6,000
-0-
Variable costing
Sales (@ $15)
25,000
20,000
5,000
30,000
4,000
24,000
30,000
6,000
36,000
15,000
15,000
-0-
$18,000
15,000
14
15
Year 1
Year 2
Year 3
$9,000
$18,000
-0-
3,000
$9,000
$3,000
$15,000
16
Variable costing NI
Variable costing NI *
Variable costing NI #
* Net income will tend to be higher under absorption costing since fixed manufacturing overhead cost will
be deferred in inventory under absorption costing.
#Net income will tend to be lower under absorption costing since fixed manufacturing overhead cost will be
released from inventory under absorption costing.
17
18
Suppose all of the facts are the same as in the previous example of Holland Company except that
production and sales are as follows:
Year 1
Year 2
Year 3
-0-
-0-
1,000
5,000
6,000
5,000
-0-
4,000
5,000
1,000
5,000
-0-
Year 2
Year 3
$5.00
$5.00
$5.00
Absorption costing
DM, DL & variable OH
Fixed manufacturing overhead
($15,000 5,000 units)
3.00
2.50
3.75
$8.00
$7.50
$8.75
19
Year 1
Year 2
Year 3
$75,000
$75,000
$75,000
-0-
-0-
7,500
Add COGM
40,000
45,000
35,000
40,000
45,000
42,500
Absorption costing
Sales (@ $15)
Less cost of goods sold:
Beginning inventory
-0-
7,500
-0-
40,000
37,500
42,500
35,000
37,500
32,500
26,000
26,000
26,000
$ 9,000
$11,500
$6,500
20
Suppose all of the facts are the same as in the previous example of Holland Company except that
production and sales are as follows:
Year 1
Year 2
Year 3
-0-
-0-
1,000
5,000
5,000
-0-
6,000
5,000
1,000
4,000
5,000
-0-
Year 2
Year 3
$5.00
$5.00
$5.00
$5.00
$5.00
$5.00
Variable costing
DM, DL & variable OH
Unit product cost
Year 2
21
Year 3
Variable costing
Sales (@ $15)
$75,000
$75,000
$75,000
25,000
25,000
25,000
5,000
5,000
5,000
30,000
30,000
30,000
Contribution margin
45,000
45,000
45,000
15,000
15,000
15,000
21,000
21,000
21,000
36,000
36,000
36,000
$ 9,000
$ 9,000
$ 9,000
22
Year 1
Year 2
Year 3
$9,000
$ 9,000
2,500
$9,000
$11,500
(2,500)
$6,500
23
a.
b.
With variable costing, changes in levels of inventories do not affect net income.
c.
d.
In variable costing, fixed costs are highlighted rather than buried in cost of goods sold
and inventories.
e.
Variable costing is easier to use in controlling costs as will be discussed in later chapters.
f.
Variable costing net income is closer to net cash flow than absorption costing net income.
But, variable costing is usually not considered acceptable for external financial reports.
If absorption costing must be used for mandatory external reports, is it worth the trouble to
maintain a different costing system for internal reports?