Variable & Absorption Costing

variable & Absorption costing
R.S.Rengasamy, Dept. of Textile Technology
Variable & Absorption costing

Variable & Absorption costing - Not job , Batch , Process costing system Variable Costing : (VC) Used for = Internal reporting for decision making w.r.t
a) b) c) d) e) Price fixing on special orders Optional sales mix Adding new product line Dropping new product line Developing production plans if certain input are in short supply f) Buy or make decision g) Selling in a limited market h) Sales mix with constraints i) Sales mix with no constraints

Absorption Costing : (AC) (Full costing , Traditional costing , Conventional costing) Used for = Income statement for external reporting / IT purposes VC & AC are not mutually exclusive complementary in nature Variable Costing :Recognises only variable costs as production and selling costs

Fixed manufacturing Over Head are excluded from product cost , not inventoriable , period costs and matches against the revenue for the period. Absorption Costing:Absorbs all cost necessary to product and have it in a saleable form. Manufacturing Over Head are inventoriable , product costs matches against the revenue for the year in which sales are made

Per year
Normal production (Kg) Actual Production (Kg) Over Head at normal production Other expenses SFR (Standard Fix Over Head rate) Variable cost Sales volume 4000 4800 Rs 16000 Rs 1000 Rs 4/ Unit
Rs 6/ Unit Nil

Income statement (Absorption Costing) Particulars A) Sales Revenue Less : Total cost of manufacturing Variable costs (64800) Fix Over Head (44800) Total B) Cost of goods manufactured Plus : Operational Inventory Less : Cost of closing Inventory (480010) 48000 Amount (Rs) 00 = 28800 = 19200 = 48000 = 0000 =
C) Cost of goods manufacturing & sold = Nil D) Gross margin (A-C) (Unadjusted) E) Capacity variance (Favourable) (over absd) *8004 ( Fixed costs inventoriable) Nil 3200

Income statement (Absorption cost) F) Gross margin (adjusted) (D+E) G) Less other expenses H) Net income before taxes continued 3200 1000 2200 ..
* Matched against revenue of the year in which sales are made

Income statement (Variable costing)
Particulars A) Sales revenue B) Variable production cost 48006 + opening inventory (variable cost) - closing inventory (variable cost) 48006 C) Cost of goods manufactured & sold D) Contribution (A-C) (Manufacturing) E) Less : Fixed costs Fixed Over Head Others Total * Non-inventoriable * At normal level F) Net income before taxes * Matched against the revenue of that year 17000 = *16000 = 1000 = 17000 = 28800 = Nil = 28800 = Nil Nil Amount (Rs) Nil

Data
P=S Year 1 Production (Units) Sales (Units) 10000 10000 P>S Year 2 10000 5000 P<S Year 3 10000 15000
Sale price @ Rs 12 Variable cost Rs 6/ unit Fixed costs/year Rs 40000(At normal capacity 10000 unit)

Income statement ( Year 1) P= S Particulars Sales (1000012) Less cost of goods manufactured Variable cost (100006) Fixed cost (100004) Cost of goods manufactured & sold Gross margin Contribution Less : Fixed cost Net income before taxes 20000 60000 40000 100000 20000 60000 40000 20000 60000 60000 Absorption cost 120000 Variable cost 120000

Income statement (Year 2) , P>S Particulars A) Sales (500012) Less : cost of goods manufactured (a) Variable cost (100006) (b) Fixed cost (i) Less : Cost of C.I 500010 500006 C) Cost of goods manufactured & sold D) G.M (A-C) Contribution Less Fixed cost Net income 10000 50000 (a+b-i) 10000 30000 40000 10000 50000 30000 30000 ( 100004) B) Cost of goods manufactured (a+b) 60000 40000 100000 60000 60000 Absorption cost 60000 Variable cost 60000

Income statement (Year 3) ,P<S
Particulars Sales 1500012 Less : cost of goods manufactured VC 100006 FC 100004 Cost of goods manufactured Plus a I 500010 500006 Cost of goods manufactured and sold Goods manufactured Contribution Less Fixed cost Net income before taxes 30000 150000 30000 90000 40000 50000 60000 40000 100000 50000 30000 90000 60000 60000 Absorption cost 180000 Variable cost 180000

Information for year 1 and 2
Year 1 Production (units) Sales (units) 170000 140000 Year 2 140000 160000
Standard variable production cost = Rs 6/Unit Sale Price = Rs 10/Unit Fixed production Over Head at normal capacity 150000 unit = 300000 Rs So, SFR = Rs 2.00 Selling & Administrative expenses:Fixed Rs 130000 Variable 5% of sales

Absorption costing
Particulars
Sales revenue Cost of manufacturing + cost of O.I - Cost of C.I Cost of goods manufactured &sold G.M (Unadjusted) Capacity variance G.M (Adjusted) Less Non production costs Net income before taxes Less income tax (35%) Net income after tax 240000(300008) 1120000 280000 40000(200002) 320000 200000 (5% of 14 Lakh+1.3 Lakh) 120000 42000 78000
Year 1
1400000 1360000 (81.7 Lakh)
Year 2
1600000 1120000(81.4 Lakh) 240000(80.3 Lakh) 80000(80.1 Lakh) 1280000 320000 20000(100002) 300000 210000 (5% of 16 Lakh+1.3 Lakh) 90000 31500 58500

Variable costing
Particulars
Sales revenue Cost of manufacturing + cost of O.I - Cost of C.I Cost of goods manufactured & sold Contribution (manufacturing) Less V. non production cost Contribution (final) Less Fixed cost Fixed Over Head Fixed selling etc. Net income before tax I-Tax Net income after tax 180000 840000 560000 70000 490000 300000 130000 60000 21000 39000
Year 1
1400000 1020000
Year 2
1600000 840000 180000 60000 960000 640000 80000 560000 300000 130000 130000 45500 84500

Reconcilation statement
Particulars Net income before tax Absorption cost Variable cost Difference Changes in inventory O.I C.I (A) Increase / Decrease in net income (SFRA),(SFR = Rs 2) 60000 40000 20000 30000 30000 30000 10000 20000 10000 10000 120000 60000 60000 90000 130000 40000 210000 190000 20000 Year 1 Year 2 Combined

Reconcilation statement(VC)
Particulars Increased in sales revenue in year 2 (20000Rs 10) Less Increased manufactured V.C (20000Rs 6) Increased contribution Less Increased selling & Administrative expense (5% of sales) Amount (Rs) 200000 120000 80000 10000
Increased contribution (final)
70000

Decision making using variable costing
Special order & special price You are operating at lower than normal capacity Some one gives extra order which boost your sales capacity But his offer in selling price is below normal price and contribution from this new offer is positive. Will you accept the order? Your normal capacity is 15000 units Your current capacity is 12000 units (beyond which you don t have local market) Your variable cost per unit is Rs.20 and selling price (Local) is Rs.30 Fixed Overhead at normal capacity = Rs 45000 Your SFOR is Rs 4500/15000 = Rs 3 Extra order is 3000 units at SP/unit = Rs 22

Using Variable costing
Additional sales revenue is (300022) = 66000 = 60000 = 6000
Less variable cost (300020) Additional contribution is
Without this special order SR (1200030) VC (1200020) Contribution Using Absorption costing Sales revenue (300022) = 360000 = 240000 = 120000
= 66000

Make or buy a component Annual requirement of a component = 20000 If the component is manufactured in-house (Company has spare capacity and no additional investment is required the cost structure per unit is Direct material = Rs 50 Direct labour = Rs 20 Variable OH = Rs 12 Fixed FOH allocated = Rs 5 Total = Rs 87 If you are outsource it the cost structure is Price = Rs 80 Ordering = Rs 3

Particular
Direct material (5020000) Direct labour (2020000) Variable OH (1220000) Purchase price (8020000) Ordering/inspection cost(320000) Total cost 1640000
Make
1000000 400000 240000
Buy
1600000 60000 1660000

Optimal sales mix (No demand constraints)
Particulars X Selling price / unit Less variable cost / unit Contribution margin /unit Time to produce /unit , hrs. (including stoppage time) CM/hour 108 60 48 24 2 Product Y 81 45 36 12 3 Z 72 40 32 8 4
If there is no manufacturing constraints (materials , labour, machine, technical competency, layout) What the firm do ?

Demand constraints
Operating capacity of company is 300 days/Year X Demand /annum 300 Y 1200 Z 1500
Total hours available = 300243 (3 lines) = 21600 All three lines can produce any of X, Y, Z For Z of 1500 unit requires 15008 Remaining hrs. available (21600-12000) Units of Y that can be produced One line exclusively allotted to Z 7200 hrs. = 12000 hrs. = 9600 = 9600/12=800 = 900 units = 600 units = 200 units
2nd line 2/3rd of time (4800 hrs.) allotted to Z 2nd line 1/3rd of time (2400 hrs.) allotted to Y 3rd line fully allotted to Y
7200 hrs.(30024 hrs.) = 600 units

Variable &amp; Absorption Costing

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Variable &amp; Absorption Costing

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variable & Absorption costing

R.S.Rengasamy, Dept. of Textile Technology