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02

VARIABLE & ABSORPTION COSTING

RHAD VIC F. ESTOQUE, CPA, MBA, CAT, MICB, RCA, CMA

Variable & Absorption Costing

RHAD VIC F. ESTOQUE, CPA MBA, CAT, MICB, RCA, CMA

I. OVERVIEW
Absorption costing includes all costs, whether variable or fixed costs, related to production. It is also known as
Full or Conventional costing. While Variable costing only includes the variable costs directly incurred in production such as
Direct Materials, Direct Labor, and Variable Overhead. It is also known as Direct costing although part of the product cost
is Variable overhead. The main difference between the two is the treatment of Fixed Overhead. Throughput costing has
only Raw Materials as product cost and treats all other cost as period cost. It is also known as Super Variable Costing.

II. PROUCT VS PERIOD COST

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A product cost is inventoried when incurred and will be only be charged against revenues only at the point of sale.
A period cost is treated as an outright expense the moment it was incurred.

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III. VARIABLE COSTING & ABSORPTION COSTING COMPARED

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1. As to treatment of the various operating costs:
Variable Absorption Throughput Super Absorption
Operating costs Costing Costing Costing Costing

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a. Direct materials product cost product cost product cost product cost
b. Direct labor- variable product cost product cost period cost product cost
c. Factory overhead
-Variable product cost product cost period cost product cost
-Fixed period cost
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product cost period cost product cost
d. Selling and administrative expense
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-Variable period cost period cost period cost product cost provided
-Fixed period cost period cost period cost it is value adding
e. Use in decision making
profitability external Theory of Life Cycle
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analysis reporting Constraints Costing

2. As to net operating income

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Relationship between
Production and Sales Net Income Inventories
a. P=S AC = VC BE = BB
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b. P>S AC > VC BE > BB

c. P<S AC < VC BE < BB

3. As to cost segregation
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Variable costing- segregates costs according to behavior

Absorption costing- segregates costs according to function

4. As to costing of inventories
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Variable costing- only variable manufacturing costs

Absorption costing- all manufacturing costs
Throughput costing- only raw materials
Super absorption costing- all manufacturing cost and non-manufacturing value adding cost
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5. As to presentation of income statement

Variable costing- Contribution Margin Income approach
Absorption costing- Conventional Income Statement.
Throughput costing- throughput contribution

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Variable & Absorption Costing

VI. RECONCILIATION OF DIRECT COSTING TO ABSORPTION COSTING NET INCOME

Net income- variable costing xxx
Add: Fixed cost in ending inventory xxx
Less: Fixed cost in beginning inventory xxx
Net income- absorption costing xxx

Illustrative Problems
1. Oswald, Inc. planned and actually manufactured 200,000 units of its single product in its first year of operations.
Variable manufacturing costs were P30 per unit of product. Planned and actual fixed manufacturing costs were P600,000,
and selling and administrative costs totaled P400,000. Oswald sold 120,000 units of its product at a selling price of P40 per
unit.
How much is the operating income under
a. Absorption (full) costing
b. Variable costing

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How much is the inventoriable cost under
a. Absorption costing

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b. Variable costing

2. The following information was provided to you by Shane Co.

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Budgeted capacity 150,000
Actual production 120,000
Sales units 100,000

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Inventory beginning balance 0
Fixed manufacturing overhead P150,000
Variable manufacturing cost P 6/unit
Selling price per unit P10/unit
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Fixed Selling and administrative expense P 30,000
Variable selling and admi P0.50
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The company applies fixed overhead based on budgeted capacity.

What would be Shane's finished goods inventory-cost under the a) variable costing method; b) absorption costing
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method?

How much is the operating income under a) absorption (full) costing b) variable costing
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3. The following information was provided by Smith Co. for the year ended December 31. There was 2,000 finished
goods inventory at January with the same variable cost but with a P4 per unit fixed overhead, and there were no work-in-
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process inventories at the beginning and end of the year.

Net sales P1,400,000
Cost of goods manufactured:
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Variable P 630,000
Fixed 315,000
Operating expenses:
Variable P 98,000
Fixed 140,000
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Units manufactured 70,000 units

Units sold 60,000 units

What would Smith's operating income be under the a) variable costing method; b) absorption costing method?
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4. Indiana Co. began its operations on January 1, and produces a single product that sells for P10 per unit. Indiana
uses an actual cost system. During the year, 100,000 units were produced and 80,000 units were sold. There was no work-
in-process inventory at December 31.
Manufacturing costs and selling administrative expenses for the year were as follows:
Fixed costs Variable costs
Raw materials P0 P2.00 per unit produced
Direct labor P0 1.25 per unit produced
Factory overhead P120,000 0.75 per unit produced
Selling and admin. 70,000 1.00 per unit sold

What would be Indiana's finished goods inventory cost at December 31, under the a) variable costing
method; b) absorption costing method?

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Variable & Absorption Costing

5. Selected information concerning the operations of Jan-Cee Co. For the year ended December 31, is available
as follows:
Units produced 10,000 units
Units sold 9,000 units
Direct materials used P40,000
Direct labor incurred 20,000
Fixed factory overhead 25,000
Variable factory overhead 12,000
Fixed selling and administrative expenses 30,000
Variable selling and administrative expenses 4,500
Finished goods inventory, January 1 none

What would be Jan-Cee's finished goods inventory cost at December 31 under the variable/direct costing method?

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Which cost method, absorption or variable costing would show a higher operating income by how much?

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6. For P1,000 per box, the Majestic Producers, Inc. produces and sells delicacies. Direct materials are P400 per
box and direct manufacturing labor averages P75 per box. Variable overhead is P25 per box and fixed overhead is
P12,500,000 per year. Administrative expenses, all fixed, run P4,500,000 per year, with sales commissions of P100 per

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box. Production is expected to be 100,000 boxes, which is met every year. For the year just ended, 75,000 boxes were
sold. What are the inventoriable costs per box using a) absorption costing; b) variable costing?

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7. Manga, Inc. manufactured 700 units last year. The ending inventory consisted of 100 units. There was no
beginning inventory. Variable manufacturing costs were P6.00 per unit and fixed manufacturing costs were P2.00 per unit.
What would be the change in the peso amount of ending inventory if variable costing were used instead of absorption
costing?
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8. Variable production costs are P12 per unit and variable selling and administrative expenses are P3 per unit.
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Fixed manufacturing overhead totals P36,000 and fixed selling and administration expenses total P40,000. Assuming a
beginning inventory of zero, production of 4,000 units and sales of 3,600 units, the peso value of the inventory end under
variable costing will be?
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9. Last year, Mayumi Company had income of P40,000 using variable costing. Beginning and ending inventories
were 22,000 and 27,000 units, respectively. If the fixed manufacturing overhead cost was P3.00 per unit, what was the
income using absorption costing?
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10. A company has a net income of P85,500 using variable costing and a net income of P90,000 using absorption
costing. Total fixed manufacturing overhead was P150,000, and production was 100,000 units. Between the beginning and
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the end of the year, the inventory level will increase or decrease by?

11. The fixed overhead per unit this year is P5 based on actual production of 5,000. If last year’s fixed overhead
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per unit is P4, how many units were produced last year.

12. A company has a net income of P71,000 using variable costing and a net income of P65,000 using absorption
costing. Total fixed manufacturing overhead was P30,000, and production was 10,000 units. How many units were sold?
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13. A company has a net income of P40,000 using variable costing and a net income of P60,000 using absorption
costing. The fixed overhead per unit is P2. If the ending inventory is 300,000 units, then how many units were in beginning
inventory?
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14. A company has a net income of P80,000 using variable costing and a net income of P100,000 using absorption
costing. Fixed manufacturing overhead per unit is P4. If the company sold 200,000 units, then how many units were
produced? How much is the total fixed overhead for the period?

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Variable & Absorption Costing

15. Reusser Company produces wood statues. Management has provided the following information:
Actual sales 80,000 statues
Budgeted production 100,000 statues
Selling price P20.00 per statue
Direct material costs P5.00 per statue
Variable manufacturing costs P1.50 per statue
Variable administrative costs P2.50 per statue
Fixed manufacturing overhead P2.00 per statue

What is the cost per statue if throughput costing is used?

What is the total throughput contribution?
Compute for the net income.

EXERCISES

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1. Which of the following statements is true for a firm that uses variable costing?
a. The cost of a unit of product changes because of changes in number of units manufactured

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b. Profits fluctuate with sales
c. An idle facility variation is calculated
d. Product costs include variable administrative costs

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2. When a firm prepares financial reports by using absorption costing
a. Profits will always increase with increases in sales

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b. Profits will always decrease with decreases in sales
c. Profits may decrease with increased sales even if there is no change in selling prices and costs
d. Deceased output and constant sales result in increased profits
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3. Absorption costing and variable costing are two different methods of assigning costs to units produced. Of the
four cost items listed below, identify the one that is not correctly accounted for as a product cost.
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Absorption Variable
Costing Costing
a. Manufacturing supplies yes yes
b. Insurance on factory yes no
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c. President’s salary no no
d. Packaging and shipping costs yes yes
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4. Jansen, Inc. pays bonuses to its managers based on operating income. The company uses absorption costing,
and overhead is applied on the basis of direct labor hours. To increase bonuses, Jansen's managers may do all of the
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following except
a. Produce those products requiring the most direct labor
b. Defer expenses such as maintenance to a future period
c. Increase production schedules independent of customer demands
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d. Decrease production of those items requiring the most direct labor

5. What costs are treated as product costs under variable costing?

a. Only variable production costs
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b. Only direct costs

c. All variable and fixed manufacturing costs
d. All variable costs

6. Which of the following is a more descriptive term of the type of cost accounting called "direct costing"?
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a. Out-of-pocket costing
b. Variable costing
c. Relevant costing
d. Prime costing

7. Which of the following comprise factory overhead?

a. All manufacturing costs
b. All manufacturing costs, except direct materials and direct labor.
c. Indirect materials but not indirect labor
d. Indirect labor but not indirect materials

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Variable & Absorption Costing

8. Manufacturing overhead includes all of the following except:

a. Indirect factory labor
b. Salary of plant manager
c. Real estate taxes on factory building
d. Depreciation on delivery equipment

9. Depreciation recognized based on output is classified as:

a. Fixed costs
b. Out-of-pocket costs
c. Marginal costs
d. Variable costs

10. A cost accounting concept, which treats fixed overhead as a product cost, is

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a. Conventional costing
b. Process costing

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c. Job-order costing
d. Standard direct costing

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11. Why is direct costing not in accordance with GAAP?
a. Fixed manufacturing costs are assumed to be period costs
b. Direct costing procedures are not well known in industry

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c. Net earnings are always overstated when using direct costing procedures.
d. Direct costing ignores the concept of lower of cost or market when valuing inventory.

12. Reporting under the direct costing concept is accomplished by:

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a. Treating all costs as period costs.
b. Eliminating the work in process inventory
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c. Matching variable costs against revenues and treating fixed costs as period costs.
d. Including only direct costs in the income statement

13. When all the manufacturing costs used in production are attached to the product, whether direct or indirect,
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variable or fixed, this is called

a. Process costing
b. Absorption Costing
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c. Variable costing
d. Job order costing
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14. Under variable costing, fixed manufacturing overhead is

a. Carried in liability account
b. Carried in an asset account
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c. Ignored
d. Immediately charged against sales as a period cost.

15. A principal difference between variable costing and absorption costing centers on:
a. Whether variable-manufacturing costs should be included as product costs.
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b. Whether fixed manufacturing costs should be included as product costs.

c. Whether fixed manufacturing costs and fixed selling and administrative costs should be included as product costs.
d. None of these
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16. Under variable costing:

a. Net income will tend to move upward and downward in response to changes in levels of production.
b. Inventory costs will always be lower than under absorption costing.
c. Net income will tend to vary inversely with production changes.
d. Net income will always be higher than under absorption costing.

17. When sales are constant, but the production level fluctuates, net income determined by the variable costing
method will:
a. Fluctuate in direct proportion to changes in production.
b. Remain constant
c. Fluctuate inversely with changes in production
d. Be greater than net income under absorption costing.

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Variable & Absorption Costing

18. Under absorption costing, fixed overhead costs:

a. Are deferred in inventory when production exceeds sales
b. Are always treated as period costs.
c. Are released from inventory when production exceeds sales
d. None of these

19. RV Company computes net income under both the absorption costing approach and the variable costing
approach. For a given year the absorption costing net income was greater than the variable costing net income. This fact
suggests that
a. Variable manufacturing costs were less than fixed manufacturing costs
b. More units were produced during the year than were sold
c. More units were sold during the year than were produced
d. Common costs were greater than variable costs for the year

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20. Net income computed using variable costing would exceed net income computed using absorption costing if;
a. Units sold exceed units produced

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b. Units sold are less than units produced
c. Units sold equals units produced
d. The unit fixed cost is zero

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21. Cay Co.'s fixed manufacturing overhead costs totaled P100,000, and variable-selling costs totaled P80,000.
Under variable costing, how should these costs be classified?

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Period Costs Product Costs
a. P 0 P180,000
b. P 80,000 P100,000
c. P100,000 P 80,000
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d. P180,000 P 0
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22. Under the variable-costing concept, unit product cost would most likely be increased by
a. A decrease in the remaining useful life of factory machinery depreciated on the units-of-production method.
b. A decrease in the number of units produced.
c. An increase in the remaining useful life of factory machinery depreciated on the sum-of the-year's-digits method.
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d. An increase in the commission paid to salesman for each unit sold.

23.In an income statement prepared as an internal report using the variable costing method, which of the following
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terms should appear?

Gross Profit (Margin) Operating Income
a. Yes Yes
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b. Yes No
c. No No
d. No Yes
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24. In an income statement prepared as an internal report using the variable costing method, variable selling and
administrative expenses are
a. Not used.
b. Treated the same as fixed selling and administrative expenses.
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c. Used in the computation of operating income but not in the computation of the contribution margin.
d. Used in the computation of the contribution margin.

25. In an income statement prepared as an internal report using the variable costing method, fixed factory overhead
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would
a. Not be used.
b. Be used in the computation of operating income but not in the computation of the contribution margin
c. Be used in the computation of the contribution margin.
d. Be treated the same as variable factory overhead.

26. Using absorption costing, fixed manufacturing overhead costs are best described as
a. Direct period costs.
b. Indirect period costs.
c. Direct product costs.
d. Indirect product costs.

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Variable & Absorption Costing

27. In an income statement prepared as an internal report, total fixed costs normally are shown separately under
Absorption Costing Variable Costing
a. No No
b. No Yes
c. Yes Yes
d. Yes No

28. Net earnings determined using full/absorption costing could be reconciled to net earnings determined using
variable costing by computing the difference between
a. Inventoried fixed costs in the beginning and ending inventories and any deferred over-or under-applied fixed
factory overhead.
b. Inventoried discretionary costs in the beginning and ending inventories.
c. Gross margin (absorption costing method) and contribution margin (variable costing method).
d. Sales as recorded under the variable costing method and sales as recorded under the absorption costing method.

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29. Net profit under absorption costing may differ from net profit determined under variable costing. This difference

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equals the change in the quantity of all units
a. In inventory times the relevant fixed costs per unit.
b. Produced times the relevant fixed costs per unit.

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c. In inventory times the relevant variable cost per unit.
d. Produced times the relevant variable cost per unit.

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30. Advocates of throughput costing argue the following, except
a. only direct materials are truly variable.
b. direct manufacturing labor is relatively fixed.
c. variable manufacturing costs are a cost of the period.
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d. variable selling expense is product cost.
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31. If 600 units are produced and only 400 units are sold, __________ results in the greatest amount of expense
reported on the income statement.
a. throughput costing
b. variable costing
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c. absorption costing
d. period costing
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32. If 400 units are produced and 600 units are sold, __________ results in the greatest amount of operating
income.
a. throughput costing
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b. variable costing
c. absorption costing
d. period costing
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33. Advocates of throughput costing maintain that

a. both variable and fixed are necessary to produce goods; therefore, both types of costs should be inventoried.
b. all manufacturing costs plus some design costs should be inventoried.
c. fixed manufacturing costs are related to the capacity to produce rather than to the actual production of specific
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units.
d. both (a) and (c) are true.
--- END OF HANDOUTS ---
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