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MS 3605 – Variable and Absorption Costing MAY 2024

LECTURE NOTES

1. Variable costing treats only those costs of released to the income statement as a charge
production that vary with output as product costs. against income as well as all of the current fixed
Ordinarily, direct materials, direct labor and manufacturing overhead costs. Since only the
variable manufacturing overhead costs would be current fixed manufacturing overhead costs are
included in product costs under variable costing. expensed under variable costing, the net income
Fixed manufacturing overhead is treated as a reported under absorption costing will be less than
period cost and is immediately charged off against the net income reported under variable costing.
revenue each period. 4. Long-term differences in income. Over an
2. Absorption costing treats all costs of production as extended period of time, the cumulative net
product costs, regardless of whether they are income figures reported under absorption costing
variable or fixed in nature. Under the absorption and variable costing will be about the same; they
costing method, a portion of fixed manufacturing will differ only by the amount of fixed
overhead is allocated to each unit of product. manufacturing overhead cost in ending inventories
under absorption costing. Cumulative net income
Comparison of Absorption and Variable Costing. figures will be identical whenever ending
When comparing absorption costing and variable inventories are reduced to zero.
costing income statements, the following points should 5. Changes in production volume. Variable costing
be noted: net income is not affected by changes in
1. Deferral of fixed manufacturing costs under production volume. Absorption costing net income
absorption costing. Under the absorption is affected by changes in production volume. For a
costing method, if inventories increase then a particular level of sales, net income under
portion of the fixed manufacturing overhead costs absorption costing will increase as the level of
of the current period is deferred to future periods output increases and hence inventories increase.
through the inventory account. When the units are
later taken out of inventory and sold, the deferred Advantages of the Contribution Approach. There
fixed costs flow through to the income statement. are several advantages in using variable costing (and
2. Differences in inventories under the two the contribution approach) in internal reports and
methods. The ending inventory figures under the analysis.
variable costing and absorption costing methods 1. More useful for CVP analysis. Variable costing
are different. Under variable costing, only the statements provide data that are immediately
variable manufacturing costs are included in useful for CVP analysis since they categorize costs
inventory. Under absorption costing, both variable based on their behavior.
and fixed manufacturing costs are included in 2. Income is not affected by changes in production
inventory. volume. Under absorption costing, reported net
income is affected by changes in production since
Suitability for CVP analysis. The absorption costing fixed costs are spread across more or fewer units.
income statement is not well suited for providing data This can distort income and may even result in
for CVP computations since it makes no distinction income moving in an opposite direction from sales.
between fixed and variable costs. In contrast, the This does not occur under variable costing.
variable costing method classifies costs by behavior 3. Avoids misunderstandings concerning unit product
and is very useful in setting-up CVP computations. costs. Absorption costing unit product costs can be
easily misinterpreted as variable costs since they
Extended Comparison of Income Data. are stated on a per unit basis. Such a
1. Production equals sales (no change in inventories). misperception can lead to serious errors in making
When production equals sales, there is no change decisions. Variable costing avoids this problem
in inventories. If there is no change in inventories, since unit costs include only variable costs.
then there is no change in the fixed manufacturing 4. Fixed costs are more visible. The impact of fixed
overhead costs in inventories under absorption costs on profits is emphasized because the total
costing. amount of such costs for the period appears
2. Production exceeds sales (inventories increase). separately and is highlighted in the income
When production exceeds sales, inventories grow. statement rather than being buried in cost of
If inventories grow, then some of the current fixed goods sold and ending inventory.
manufacturing overhead costs will be deferred in 5. Understandability. Managers may find it easier to
inventories under absorption costing. Since all of understand variable costing reports because data
the current fixed manufacturing overhead costs are organized by behavior and because variable
are expensed under variable costing, the net costing is much closer to a cash flow concept.
income reported under absorption costing will be 6. Control is facilitated. Variable costing ties in with
greater than the net income reported under cost control methods such as flexible budgets.
variable costing. 7. Incremental analysis is more straight-forward.
3. Sales exceeds production (inventories decrease). Variable cost corresponds closely with the current
When sales exceeds production, inventories shrink. out-of-pocket expenditure necessary to produce
If inventories decrease, then some of the fixed and sell products and services and can therefore
manufacturing overhead costs that had been be used more readily in incremental analysis than
deferred in inventories in previous periods will be absorption costing data. And since variable costing

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net income is closer to net cash flow than PROBLEM NO. 4.

absorption costing net income, it is likely to be Golden Gate Company makes network connectors that
more useful to companies that have cash flow sell for P500. Standard variable manufacturing cost is
problems. P200, and the standard fixed manufacturing cost is
STRAIGHT PROBLEMS P100, based on budgeted fixed cost of P10 millions
and budgeted production of 100,000 units. During
PROBLEM NO. 1. 2020, the company produced 96,000 units sold
Baker Company produced 30,000 units and sold 90,000. Actual fixed manufacturing costs were
28,000 units. Beginning inventory was zero. During P9,870,000; actual variable manufacturing costs were
the period, the following costs were incurred: P19,300,000. Selling and administrative expenses
Indirect labor P60,000 were P11,350,000, all fixed. There were no beginning
Indirect materials 30,000 inventories.
Other variable overhead 90,000
Fixed manufacturing 180,000 Requirements:
overhead 1. Prepare in income statement for Golden Gate
Fixed administrative 150,000 using standard variable costing.
expenses 2. Prepare a standard absorption costing income
Fixed selling expenses 120,000 statement.
Variable selling expenses, per unit 40
Direct labor, per unit 80 PROBLEM NO. 5.
Direct materials, per unit 20 Shark Company began operations on January 1 to
produce a fishing rods. It used a standard absorption
Requirements: costing system with a planned production volume of
Compute the peso amount of ending inventory using: 100,000 units. During its first year of operations, no
1. Absorption costing variances were incurred and there were no fixed
2. Variable costing selling or administrative expenses. Inventory on
December 31 was 20,000 units, and net income for
PROBLEM NO. 2. the year was P480,000. If Shark had used variable
Luzon Manufacturing Company began its operations on costing, its net income would have been P440,000.
January 1 and it produces a single product that sells Compute the breakeven point in units.
for P45 per unit. During the year, 60,000 units of the
product were produced, 55,000 of which were sold. PROBLEM NO. 6.
There was no work in process inventory at the end of During its first year of operations, Gold, Inc. produced
the year. Manufacturing and marketing and 27,000 units. Unit sales were 26,400. Fixed overhead
administrative expenses for the year were as follows: was applied at P0.75 per unit produced. Fixed
Fixed Variable overhead was underapplied by P3,000. This fixed
Materials P12 per unit produced overhead variance was closed to Cost of Goods Sold.
Direct labor P8 per unit produced There was no variable overhead variance. The results
Factory OH P420,000 P6 per unit produced of the year’s operations are as follows (on an
Marketing & P180,000 P4 per unit sold absorption-costing basis):
admin.
Sales (26,400 units @ P12) P 316,800
Requirements: Less: Cost of goods sold 161,400
1. Compute the unit cost using variable costing. Gross margin P 155,400
2. Compute the unit cost using absorption costing. Less: Selling and administrative
3. Compute the amount of income under: expenses (all fixed) 120,000
a. Traditional costing Operating income P 35,400
b. Variable costing
c. Throughput costing Requirements:
1. Give the cost of the firm’s ending inventory under
PROBLEM NO. 3. absorption costing. What is the cost of the
RV Corporation has fixed manufacturing cost of P8 per ending inventory under variable costing?
unit. Consider the three independent cases that follow. 2. Prepare a variable-costing income statement.
Case A: Absorption- and variable costing net
income each totaled P160,000 in a period MULTIPLE CHOICE QUESTIONS
when the firm produces 20,000 units.
Case B: Absorption-costing net income totaled 1. If a firm produces more units than it sells,
P180,000 in a period when finished-goods absorption costing, relative to variable costing, will
inventory level rises by 5,000 units. result in
Case C: Absorption-costing net income and a. higher income and assets
variable-costing net income respectively b. lower income but lower assets
totaled P240,000 and P272,000 in a period c. higher income but lower assets
when the beginning finished-goods inventory d. lower income and assets
was 14,000 units.
2. Under absorption costing, if sales remain constant
Requirements: from period 1 to period 2, the company will report a
1. In Case A, how many units were sold during the larger income in period 2 when
period? a. period 2 production exceeds period 1 production
2. In Case B, how much income would RV Company b. period 1 production exceeds period 2 production
report under variable costing?
3. In Case C, how many units were in the ending
finished-goods inventory?

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c. variable production costs are larger in period 2 a. Direct period costs.

than period 1 b. Indirect period costs.
d. fixed production costs are larger in period 2 than c. Direct product costs.
period 1 d. Indirect product costs.

3. The variable costing format is often more useful to 10. Which of the following groups prefer variable
managers than the absorption costing format costing for their reporting?
because A. Internal decision maker
a. costs are classified by their behavior B. Bureau of Internal Revenue
b. it is required for external reporting C. Stockholders
c. costs are always lower D. Securities & Exchange Commission
d. it justifies higher product prices
11. How will a favorable volume variance affect net
4. When a firm prepares financial reports using income under each of the following methods?
absorption costing Absorption Variable
a. profits will always increase with increase in sales a. Reduce No effect
b. profits will always decrease with decreases in b. Reduce Increase
sales c. Increase No effect
c. profits may decrease with increased sales even if d. Increase Reduce
there is no change in selling prices and costs
d. decreased output and constant sales result in 12. Assuming absorption costing, which of the following
increased profits columns includes only product costs?
A B C D
5. Which of the following statements is true for a firm Direct labor X X X
that uses variable costing? Direct materials X X X
a. The cost of a unit of product changes because of Sales materials X
changes in the number of units manufactured Advertising costs X
b. Profits fluctuate with sales Indirect factory materials X X X
c. An idle facility variation is calculated
Indirect labor X X X
d. None of the given choices
Sales commissions X
Factory utilities X X X
6. Net income determined using full absorption costing
Administrative supplies X
can be reconciled to net income determined using
expense
variable costing by computing the difference
between: Administrative labor X
A. fixed manufacturing overhead costs deferred in Depreciation on X
or released from inventories. administration building
B. inventoried discretionary costs in the beginning Cost of research on X
and ending inventories. customer demographics
C. gross margin (absorption costing method) and A. A. C. C.
contribution margin (variable costing method). B. B. D. D.
D. sales as recorded under the variable costing
method and sales as recorded under the 13. Which of the following is(are) closely related to
absorption costing method. variable costing than to absorption costing?
1. Predetermined fixed overhead
7. Which of the following statements is correct? 2. Unit sales
A. When production is higher than sales, absorption 3. Production units
costing net income is lower than variable costing 4. Contribution margin
net income 5. Gross margin
B. If all products manufactured during the period 6. Volume variance
are sold in that period, variable costing net 7. Cost behavior
income is equal to absorption costing net 8. Management accounting
income.
C. When production is lower than sales, variable A. 1, 2, 4, 6, 7, 8
costing net income is lower than absorption B. 2, 4, 7, 8
costing net income C. 1, 3, 4, 7, 8
D. When production and sales level are equal, D. 1, 3, 5, 6
variable costing net income is lower than
absorption costing net income. 14. At its present level of operations, a small
manufacturing firm has total variable costs equal to
8. As compared with total absorption costing profit 75% of sales and total fixed costs equal to 15% of
over the entire life of a company, total variable sales. Based on variable costing, if sales change by
costing profit will be P1.00, income will change by
A. less a. P0.25 c. P0.75
B. greater b. P0.10 d. Undeterminable
C. equal
D. substantially greater or less depending upon 15. Gabbert Company, which has only one product, has
external factors provided the following data concerning its most
recent month of operations:
9. Using absorption costing, fixed manufacturing Units sold @ P90 per unit 3,400
overhead costs are best described as Units produced 3,600
Beginning inventory 0

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manufacturing overhead costs were P4 per unit. The

Costs Variable Fixed Cost company's net operating income for the year was
Cost P24,000 higher under absorption costing than it was
Direct materials P23 under variable costing. Given these facts, the
Direct labor 11 number of units in the ending inventory must have
Manufacturing overhead 2P 93,600 been:
Selling and administrative 8 61,200 a. 22,000 units c. 6,000 units
expenses b. 10,000 units d. 4,000 units
What is the total period cost for the month under
the variable costing approach? 20. This year, Roberts Company's income under
a. P93,600 absorption costing was P2,000 lower than its
b. P154,800 income under variable costing. The company sold
c. P88,400 8,000 units during the year, and its variable costs
d. P182,000 were P8 per unit, of which P2 was variable selling
expense. If production cost was P10 per unit under
16. Three new companies (X, Y, and Z) began absorption costing, then how many units did the
operations on January 1. Consider the following company produce during the year?
operating costs that were incurred by these A. 7,500 units.
companies during the complete calendar year: B. 7,000 units.
Company X Company Y Company Z C. 9,000 units.
D. 8,500 units.
Production in units 10,000 10,000 10,000
Sales price per unit P10 P10 P10
21. Southseas Corp. uses a standard cost system. The
Fixed prod’n costs P10,000 P20,000 P30,000
standard cost per unit of one of its products are as
Variable prod’n costs P30,000 P20,000 P10,000
follows:
Variable SG&A P10,000 P20,000 P30,000
Fixed SG&A P30,000 P20,000 P10,000 Direct Materials P4.00
Based on sales of 7,000 units, which company will Direct labor 6.00
report the greater income before income taxes Factory overhead
under variable costing? Variable 3.00
a. Company X Fixed (based on a normal
b. Company Y capacity of 10,000 units) 2.00
c. Company Z Total 15.00
d. All of the companies will report the same income.
Beginning inventory 2,000 units
17. A company manufactures a single product for its Production 8,000 units
customers by contracting in advance of production. Units sold (selling price P50) 7,000 units
Thus, the company produces only units that will be Actual costs:
sold by the end of each period. For the last period, Direct materials P 35,000
the following data were available: Direct labor 50,000
Sales P40,000 Variable overhead 23,000
Direct materials 9,050 Fixed overhead 18,000
Direct labor 6,050 Variable selling and administrative 60,000
Rent (9/10 factory, 1/10 office) 3,000 Fixed selling and administrative 35,000
Depreciation on factory equipment 2,000 Variances are closed to cost of sales monthly.
Supervision (2/3 factory, 1/3 office) 1,500 How much are the net income under absorption
Salespeople’s salaries 1,300 costing and variable costing methods?
Insurance (2/3 factory, 1/3 office) 1,200 Absorption Variable
Office supplies 750 a. 144,000 143,000
Advertising 700 b. 143,000 144,000
Depreciation on office equipment 500 c. 144,000 142,000
Interest on loan 300 d. 142,000 144,000
The gross profit margin percentage (rounded) was
a. 34% c. 44% Use the following information for the next two questions.
b. 41% d. 46% The following data are available for X Co. for its first
year of operations:
18. Lauder Company produces a single product. During Sales in units 5,000
March, the company had net operating income Production in units 8,000
under absorption costing that was P3,500 lower Manufacturing costs:
than under variable costing. The company sold Direct labor P3 per unit
7,000 units in March, and its variable costs were P7 Direct materials P5 per unit
per unit, of which P3 was variable selling expense. Variable overhead P1 per unit
If fixed manufacturing overhead was P2 per unit Fixed overhead P100,000
under absorption costing, then how many units did Net income (absorption method) P30,000
the company produce during March? Sales price per unit P40
a. 5,250 units c. 6,500 units
b. 8,750 units d. 6,125 units 22. What would X Co. have reported as its income
before tax if it had used variable costing?
19. Company B produces a single product. The a. P30,000 c. P67,500
company had 16,000 units in its beginning b. P(7,500) d. P45,000
inventory. During the year, the company's variable
production costs were P6 per unit and its fixed

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23. What was the total amount SG&A expense incurred

by X Co.? 26. What is Cost of Goods Sold for Soconfused Co.’s
a. P30,000 c. P6,000 first year?
b. P62,500 d. P45,000 a. P80,000 c. P48,000
b. P90,000 d. Undeterminable
Use the following information for the next two questions.
Sales and costs data for Maripaz Corporation’s new 27. If Soconfused Co. had used variable costing in its
product are as follows: first year of operations, how much income (loss)
Sales (P22.50 per unit) P225,000 before taxes would they have reported?
Unit Fixed Cost a. P(6,000) c. P26,000
Variable b. P54,000 d. P 2,000
Cost*
Manufacturing cost P12.00 P37,500 28. Based on variable costing, if Soconfused had sold
Administrative cost 4.50 22,500 12,001 units instead of 12,000, its income before
* per unit of production. taxes would have been
There was no inventory at the beginning of the year. a. P9.50 higher c. P8.50 higher
Normal capacity of the plant is 12,500 units. During the b. P11.00 higher d. P8.33 higher
year, 12,500 units were manufactured.
24. The total fixed cost charged to expense for the year Use the following information for the next two questions.
under the absorption costing shall be Reusser Company produces wood statues. Management
a. P48,000 has provided the following information:
b. P52,500 Actual sales 80,000 statues
c. P55,500 Budgeted production 100,000 statues
d P60,000. Selling price P20.00 per statue
Direct material costs P5.00 per statue
25. The cost of ending inventory under the direct Variable manufacturing costs P1.50 per statue
costing and absorption costing shall be as follows: Variable administrative costs P2.50 per statue
a. b. c. d. Fixed manufacturing overhead P2.00 per statue
Direct costing P30,000 P30,000 P37,500 P37,500
Absorption costing P37,500 P30,000 P30,000 P37,500 29. What is the cost per statue if throughput costing is
used?
a. P11.00 c. P7.50
Use the following information for the next three questions.
b. P9.50 d. P5.00
The following information was extracted from the first
year of absorption-based accounting records of
30. What is the total throughput contribution?
Soconfused Co.
a. P1,500,000 c. P720,000
Total fixed costs incurred P100,000
b. P2,000,000 d. P1,200,000
Total variable costs incurred 50,000
Total period costs incurred 70,000
Total variable period costs incurred 30,000
Units produced 20,000
Units sold 12,000
Unit sales Price P12

"No one is going to give you a map; you have to walk your own path." - Anonymous

– end -

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