FULL (ABSORPTION) AND VARIABLE

COSTING
Income statements
of manufacturing firms
prepared for external purposes use full costing
(also called absorption costing).
In full costing, inventory costs include direct
material, direct labor, and all manufacturing
overhead.
In variable costing, only variable production
costs are included in inventory costs. All fixed
production costs are treated as period costs
and expensed in the period incurred.
Selling price per unit
$2,000
Variable production costs per unit:
Direct material
$600
Direct labor
225

Fixed manufacturing overhead per year

$1,200,000
Fixed selling expense
$100,000
Fixed administrative expense
$500,000
ClausenTube
There is no Income
beginning
inventory of finished
Statement
goods,
5,000
are
produced,
For the
Yearunits
Ended
December
31, and
20065,000
units
are sold.
Full
Costing
Sales ($2,000 X 5,000 units)
$10,000,000
Cost of goods sold ($1,140 X 5,000 units)
5,700,000
Gross
margin
4,300,000
Less selling and administrative expense:
Selling expense
$ 300,000

Variable Costing
Sales ($2,000 X 5,000 units)
$10,000,000
Less variable costs:
Variable cost of goods sold
($900 X 5,000 units)
$4,500,000
Variable selling costs ($40 X 5,000)
200,000 4,700,000
Contribution
margin
5,300,000
Less fixed costs:
Fixed production costs
1,200,000
Fixed selling costs
100,000
Fixed administrative costs
500,000 1,800,000
Net income
$3,500,000
Note: Units produced and sold both equal 5,000.

QUANTITY PRODUCED IS GREATER THAN

In this case, income
will be
greater using full
QUANTITY
SOLD

costing as opposed to variable costing. Lets

see why this is the case.
ClausenTube increased production to 6,000
units but only sold
4,800 due to a weakening
ClausenTube
economy.
Income Statements
For the Year Ended December 31, 2007
Full Costing
Sales ($2,000 X 4,800 units)
$9,600,000
Cost of goods sold ($1,110 X 4,800 units)
5,280,000
Gross
margin
4,320,000
Less selling and administrative expense:
Selling expense
$ 292,000

Variable Costing
Sales ($2,000 X 4,800 units)
$9,600,000
Less variable costs:
Variable cost of goods sold
($900 X 4,800 units)
$4,320,000
Variable selling costs ($40 X 4,800)
192,000 4,512,000
Contribution
margin
5,088,000
Less fixed costs:
Fixed production costs
1,200,000
Fixed selling costs
100,000
Fixed administrative costs
500,000 1,800,000
Net income

Full Costing Inventory value

Cost Per Unit
Direct material per unit
$ 600
Direct labor per unit
225
Variable manufacturing overhead
75
Fixed manufacturing overhead
($1,200,000 6,000 units)
200
Total
$1,100
Ending Inventory Value
($1,100 X 1,200 units)
$1,320,000
Variable Costing Inventory Value
Difference
of
Cost Per Unit
$240,000
Direct material per unit
$ 600 due to
$200 per unit of
Direct labor per unit
225
fixed
Variable manufacturing overhead manufacturing
75
overhead
in
Total
$ 900
ending inventory
Ending Inventory Value
under full costing
($900 X 1,200 units)
$1,080,000

QUANTITY PRODUCED IS LESS THAN

QUANTITY
SOLD
When the beginning
inventory is charged to
cost of goods sold, the charge will be higher
under full costing. The result income is lower
under full costing when the quantity produced
is less than the quantity sold.

BENEFITS OF VARIABLE COSTING FOR

INTERNAL
Managers simply
cant REPORTING
estimate accurately the

impact of changes in volume on cost and profit

unless they know which costs are fixed and
which costs are variable.
Another reason why variable costing may be
preferred for internal purposes is that it does
not allow managers to artificially inflate profit
by producing more units than they can sell.

Explain
the
difference
between
full
(absorption) and variable costing. In full
costing, product cost includes direct material,
direct
labor,
and
variable
and
fixed
manufacturing overhead. In variable costing,
fixed manufacturing overhead is not included
in product cost. Rather, it is treated as a
period expense.
Discuss the effect of production on full and
variable costing income. If the quantity
produced equals the quantity sold, there is no
difference in income. If the quantity produced
exceeds the quantity sold, full costing income
is higher than variable costing income. If the
quantity produced is less than the quantity
sold, full costing income is less than variable
costing income.