Variable Costing vs Absorption Costing

Summary

This video explains the differences between absorption costing and variable costing. Absorption costing includes all manufacturing costs (direct materials, direct labor, and both variable and fixed factory overhead) in product costs, affecting inventory and cost of goods sold. Variable costing, on the other hand, treats fixed factory overhead as a period cost, expensing it immediately and including only variable manufacturing costs in product costs. The video highlights how these costing methods impact financial statements, particularly when production and sales volumes differ.

Takeaways

• 😀 Managerial accounting helps present financial information in various formats for decision-making.
• 😀 The contribution format income statement distinguishes between variable and fixed costs.
• 😀 Absorption costing includes all manufacturing costs (direct materials, direct labor, and factory overhead) as product costs.
• 😀 In absorption costing, fixed factory overhead is allocated per unit and included in inventory and cost of goods sold.
• 😀 Variable costing treats only variable manufacturing costs (direct materials, direct labor, and variable factory overhead) as product costs.
• 😀 Fixed factory overhead is excluded from product costs under variable costing and treated as a period expense.
• 😀 The per-unit cost under absorption costing includes both variable costs and a portion of fixed factory overhead.
• 😀 The per-unit cost under variable costing includes only variable costs, excluding fixed factory overhead.
• 😀 The difference in net operating income between absorption and variable costing arises when the number of units produced differs from the number sold.
• 😀 Under absorption costing, fixed factory overhead is divided between sold units (cost of goods sold) and unsold units (inventory).
• 😀 Under variable costing, all fixed factory overhead is expensed in the period the products are made, regardless of whether they are sold.

Q & A

What is the main difference between absorption costing and variable costing?

The main difference between absorption costing and variable costing lies in the treatment of fixed factory overhead. Under absorption costing, fixed factory overhead is included in product costs, whereas under variable costing, it is treated as a period cost and expensed in the period incurred.

What costs are included in product costs under absorption costing?

Under absorption costing, all manufacturing costs, including direct materials, direct labor, and both variable and fixed factory overhead, are included in product costs.

How are fixed factory overhead costs treated differently under absorption and variable costing?

Under absorption costing, fixed factory overhead is allocated to the units produced, forming part of the product cost and included in inventory and cost of goods sold. In contrast, under variable costing, fixed factory overhead is treated as a period cost and expensed immediately in the period incurred.

What is the unit product cost using absorption costing in the example provided?

In the example, the unit product cost using absorption costing is $54.50, which includes $18 for direct materials, $12 for direct labor, $7 for variable factory overhead, and $17.50 for fixed factory overhead per unit.

What is the unit product cost using variable costing in the example provided?

Under variable costing, the unit product cost is $37, which includes $18 for direct materials, $12 for direct labor, and $7 for variable factory overhead. Fixed factory overhead is treated as a period cost and is not included in the unit product cost.

How does absorption costing affect the income statement when units produced differ from units sold?

When units produced differ from units sold, absorption costing splits fixed factory overhead between units sold (which appear in the cost of goods sold on the income statement) and units still in inventory (which appear on the balance sheet). The fixed factory overhead is expensed when the units are sold.

Why might the net operating income be different under absorption costing and variable costing?

The net operating income will differ between absorption costing and variable costing due to the different treatment of fixed factory overhead. Under absorption costing, fixed factory overhead is deferred in inventory if not all units are sold, whereas under variable costing, it is expensed in the period incurred.

How is fixed factory overhead treated under variable costing when units are produced but not sold?

Under variable costing, all fixed factory overhead is expensed immediately in the period in which the units are produced, regardless of whether the units are sold or not.

What impact does the inclusion of fixed factory overhead in product costs have on inventory valuation in absorption costing?

In absorption costing, the inclusion of fixed factory overhead in product costs increases the valuation of inventory because a portion of the fixed overhead is allocated to units that are still in inventory. This results in a higher inventory value and potentially a lower expense in the current period.

How would net operating income change if all units produced were sold under absorption costing?

If all units produced were sold under absorption costing, the net operating income would reflect the full allocation of fixed factory overhead to the units sold. In this case, the fixed factory overhead would be expensed as part of the cost of goods sold, and there would be no deferred overhead in inventory.