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Absorption and
Variable Costing
McGraw-Hill/Irwin
Learning
Objective
1
McGraw-Hill/Irwin
Absorption Costing
A system of accounting for costs in which
both fixed and variable production costs
are considered product costs.
Fixed
Costs
Product
Variable
Costs
Variable Costing
A system of cost accounting that only
assigns the variable cost of production to
products.
Fixed
Costs
Product
Variable
Costs
Product costs
Variable
Costing
Direct materials
Direct labor
Variable mfg. overhead
Product costs
Product costs
Variable
Costing
Direct materials
Direct labor
Variable mfg. overhead
Product costs
Learning
Objective
2
McGraw-Hill/Irwin
25,000
10
$ 150,000
$ 100,000
Absorption
Costing
Variable
Costing
10
10
6
16
10
Absorption Costing
Income Statements
Mellon Co. had no beginning inventory, produced 25,000
units and sold 20,000 units this year at $30 each.
Absorption Costing
Sales (20,000 $30)
Less cost of goods sold:
Beginning inventory
Add COGM
Goods available for sale
Ending inventory
Gross margin
Less selling & admin. exp.
Variable
Fixed
Net income
$ 600,000
Absorption Costing
Income Statements
Mellon Co. had no beginning inventory, produced 25,000
units and sold 20,000 units this year at $30 each.
Absorption Costing
Sales (20,000 $30)
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
Gross margin
Less selling & admin. exp.
Variable
Fixed
Net income
$ 600,000
320,000
$ 280,000
Absorption Costing
Income Statements
Mellon Co. had no beginning inventory, produced 25,000
units and sold 20,000 units this year at $30 each.
Absorption Costing
Sales (20,000 $30)
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
Gross margin
Less selling & admin. exp.
Variable (20,000 $3)
$ 60,000
Fixed
100,000
Net income
$ 600,000
320,000
$ 280,000
160,000
$ 120,000
Learning
Objective
3
McGraw-Hill/Irwin
Variable Costing
Income Statements
Now lets look at variable costing by Mellon Co.
Variable Costing
Sales (20,000 $30)
Less variable expenses:
Beginning inventory
$
Add COGM
Goods available for sale
Ending inventory
Variable cost of goods sold
Variable selling & administrative
expenses
Contribution margin
Less fixed expenses:
Manufacturing overhead
Selling & administrative expenses
Net income
$ 600,000
-
Variable Costing
Income Statements
Now lets look at variable costing by Mellon Co.
We exclude the
Variable
Costing
fixed
manufacturing
$ 600,000
overhead.
Variable Costing
Income Statements
Now lets look at variable costing by Mellon Co.
Variable Costing
Sales (20,000 $30)
Less variable expenses:
Beginning inventory
Add COGM (25,000 $10)
Goods available for sale
Ending inventory (5,000 $10)
Variable cost of goods sold
Variable selling & administrative
expenses (20,000 $3)
Contribution margin
Less fixed expenses:
Manufacturing overhead
Selling & administrative expenses
Net income
$ 600,000
$
250,000
$ 250,000
50,000
$ 200,000
60,000
$ 150,000
100,000
260,000
$ 340,000
250,000
$ 90,000
Ending
Inventory
Period
Expense
Total
Ending
Inventory
Period
Expense
Absorption costing
Variable mfg. costs $ 200,000
Fixed mfg. costs
120,000
$ 320,000
$ 50,000
30,000
$ 80,000
Variable costing
Variable mfg. costs $ 200,000
Fixed mfg. costs
$ 200,000
$ 50,000
$ 50,000
150,000
$ 150,000
Total
Ending
Inventory
Period
Expense
Absorption costing
Variable mfg. costs $ 200,000
Fixed mfg. costs
120,000
$ 320,000
$ 50,000
30,000
$ 80,000
Variable costing
Variable mfg. costs $ 200,000
Fixed mfg. costs
$ 200,000
$ 50,000
$ 50,000
150,000
$ 150,000
Total
$ 250,000
150,000
$ 400,000
$ 250,000
150,000
$ 400,000
Learning
Objective
4
McGraw-Hill/Irwin
90,000
30,000
120,000
Learning
Objective
5
McGraw-Hill/Irwin
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.
Learning
Objective
6
McGraw-Hill/Irwin
Lets look at
the second
year of
operations
for Mellon
Company.
25,000
10
$ 150,000
$ 100,000
Absorption
Costing
Variable
Costing
10
10
6
16
10
$ 900,000
$ 80,000
400,000
$ 480,000
-
$ 90,000
100,000
480,000
$ 420,000
190,000
$ 230,000
$ 900,000
$ 80,000
400,000
$ 480,000
-
$ 90,000
100,000
480,000
$ 420,000
190,000
$ 230,000
$ 900,000
$
50,000
250,000
$ 300,000
$ 300,000
90,000
$ 150,000
100,000
390,000
$ 510,000
250,000
$ 260,000
Summary
Income Comparison
Costing Method
Absorption
Variable
1st Period
$ 120,000
90,000
2nd Period
$ 230,000
260,000
Total
$ 350,000
350,000
Summary
Income Comparison
Costing Method
Absorption
Variable
1st Period
$ 120,000
90,000
2nd Period
$ 230,000
260,000
Total
$ 350,000
350,000
Summary
Lets see if we can get an overview
of what we have done.
Summary Comparison of
Absorption (AC) and Variable
Costing (VC)
Summary Comparison of
Absorption (AC) and Variable
Costing (VC)
Summary Comparison of
Absorption (AC) and Variable
Costing (VC)
Summary Comparison of
Absorption (AC) and Variable
Costing (VC)
Production versus
Sales
Total
Inventory
Effect
Increase
Profit Effect
Fixed mfg.
< costs expensed
VC
AC > VC
Fixed mfg.
Fixed mfg.
costs expensed = costs expensed
AC
VC
AC = VC
No change
Advantages
Impact of fixed
costs on profits
emphasized.
Consistent with
CVP analysis.
Emphasizes contribution in
short-run pricing decisions.
Advantages
External reporting
and income tax law
require absorption costing.
Production tends
to equal sales . . .
Learning
Objective
7
McGraw-Hill/Irwin
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
overproduce
is reduced
Advantages
Learning
Objective
8
McGraw-Hill/Irwin
$600,000
150,000
$450,000
375,000
$ 75,000
End of Chapter 8
TheEnd