Absorption Costing and Variable Costing

Summary

This script provides an in-depth explanation of absorption and variable costing methods. It outlines how each method treats manufacturing costs, including direct materials, direct labor, and both variable and fixed overheads. The script also compares income statements under both methods, analyzing how costs impact net income. Furthermore, it calculates cost per unit for a corporation producing 900 units, emphasizing the treatment of fixed overhead in both absorption and variable costing. The analysis includes the contribution margin and ending inventory valuation under both costing methods.

Takeaways

• 😀 Absorption costing is a product costing method that includes all manufacturing costs, such as direct materials, direct labor, and both variable and fixed overheads.
• 💼 Variable costing only includes variable manufacturing costs like direct materials, direct labor, and variable overhead, excluding fixed overhead costs.
• 🏗️ Manufacturing costs under absorption costing are higher than under variable costing, as absorption includes fixed factory overheads.
• 📊 Absorption costing impacts the income statement by including fixed overhead costs in inventory, which affects net income.
• 🛠️ Under variable costing, fixed overhead is treated as a period expense, impacting the income statement differently than absorption costing.
• 💰 Net income can differ under absorption costing and variable costing depending on the amount of inventory held during the period.
• 🔍 The product cost per unit under absorption costing includes direct materials, direct labor, variable factory overhead, and fixed factory overhead.
• 📈 The income statement under absorption costing typically shows higher inventory values and net income when inventory levels increase.
• 📉 Variable costing leads to a lower net income when inventory levels decrease, as fixed overheads are expensed in the period they occur.
• 🏢 Ending inventory is calculated differently under absorption costing and variable costing, with absorption typically resulting in higher inventory values.

Q & A

What is absorption costing?

Absorption costing is a product costing method that includes all manufacturing costs, such as direct materials, direct labor, variable overhead, and fixed overhead, in the cost of the product.

What are the key components included in absorption costing?

Absorption costing includes direct materials, direct labor, variable factory overhead, and fixed factory overhead in the total manufacturing cost.

How does variable costing differ from absorption costing?

Variable costing only includes variable manufacturing costs, such as direct materials, direct labor, and variable overhead, while fixed overhead is treated as a period expense.

How is net income calculated under absorption costing?

Under absorption costing, net income is calculated by subtracting total expenses (including fixed and variable costs) from total revenue, with all manufacturing costs allocated to inventory until the goods are sold.

How does the income statement under variable costing differ from absorption costing?

In variable costing, the income statement is based on contribution margin, where only variable costs are deducted from revenue, and fixed costs are treated as period expenses, unlike absorption costing which allocates fixed overhead to product costs.

What are the advantages of absorption costing?

Absorption costing provides a more comprehensive view of the total cost of manufacturing, as it includes fixed overhead. It is also required by accounting standards for external reporting.

What are the advantages of variable costing?

Variable costing provides a clearer picture of how variable costs impact profitability and makes it easier to assess the impact of changes in production volume on net income.

How is ending inventory valued under absorption costing?

Under absorption costing, ending inventory is valued by including all manufacturing costs (direct materials, direct labor, variable, and fixed overhead) in the cost of unsold units.

How is ending inventory valued under variable costing?

Under variable costing, ending inventory only includes variable manufacturing costs (direct materials, direct labor, and variable overhead), excluding fixed overhead.

What impact does absorption costing have on net income when production exceeds sales?

When production exceeds sales under absorption costing, some fixed overhead costs are included in ending inventory, which defers the expense to future periods, resulting in higher net income in the current period.