Variable vs. Absorption Costing

Variable vs Absorption
Costing
5-2
Learning Objective 1
Explain how variable costing differs

from absorption costing and compute
unit product costs under each method.
5-3
Overview of Absorption and

Variable Costing
Absorption Variable
Costing Costing
Direct Materials
Product
Product Direct Labor
Costs
Costs Variable Manufacturing Overhead
Fixed Manufacturing Overhead

Period
Period Variable Selling and Administrative Expenses
Costs
Costs Fixed Selling and Administrative Expenses
5-4
Quick Check ✓
Which method will produce the highest values
for work in process and finished goods
inventories?
a. Absorption costing.
b. Variable costing.
c. They produce the same values for these
inventories.
d. It depends.
5-5
Quick Check ✓
Which method will produce the highest values
for work in process and finished goods
inventories?
a. Absorption costing.
b. Variable costing.
c. They produce the same values for these
inventories.
d. It depends.
5-6
Unit Cost Computations

Harvey Company produces a single product
with the following information available:
5-7

Unit product cost is determined as follows:
Selling and administrative expenses are

always treated as period expenses and
deducted from revenue as incurred.
5-8
Prepare income statements using both

variable and absorption costing.
5-9
Income Comparison of
Absorption and Variable Costing
Let’s assume the following additional information
for Harvey Company.
• 20,000 units were sold during the year at a price of
$30 each.
• There is no beginning inventory.
Now, let’s compute net operating

income using both absorption
and variable costing.
5-10
Absorption Costing
5-11
Variable Costing
Variable
manufacturing
Variable Costing
costs only.
Sales (20,000 × $30) $ 600,000
Less variable expenses:
Beginning inventory $ -
All fixed
Add COGM (25,000 × $10) 250,000
manufacturing
Goods available for sale 250,000
overhead is
Less ending inventory (5,000 × $10) 50,000
expensed.
Variable cost of goods sold 200,000
Variable selling & administrative
expenses (20,000 × $3) 60,000 260,000
Contribution margin 340,000
Less fixed expenses:
Manufacturing overhead $ 150,000
Selling & administrative expenses 100,000 250,000
Net operating income $ 90,000
5-12
Extended Comparison of Income

Data Here is information about the operation
of Harvey Company for the second year.
5-13
Since there was no change in the variable costs

per unit, total fixed costs, or the number of
units produced, the unit costs remain unchanged.
5-14
Absorption Costing
Absorption Costing
Sales (30,000 × $30) $ 900,000
Less cost of goods sold:
Beg. inventory (5,000 × $16) $ 80,000
Add COGM (25,000 × $16) 400,000
Goods available for sale 480,000
Less ending inventory - 480,000
Gross margin 420,000
Less selling & admin. exp.
Variable (30,000 × $3) $ 90,000
Fixed 100,000 190,000
Net operating income $ 230,000
These are the 25,000 units

produced in the current period.
5-15
Variable
Variable Costing manufacturing
costs only.
All fixed
manufacturing
overhead is
expensed.
5-16
Reconcile variable costing and

absorption costing net operating
incomes and explain why the two
amounts differ.
5-17
Comparing Absorption and

Variable Costing: Year 1
Let’s compare the methods.
5-18

We can reconcile the difference between absorption
and variable net operating income as follows:
Variable costing net operating income $ 90,000
Add: Fixed mfg. overhead costs
deferred in inventory
(5,000 units × $6 per unit) 30,000
Absorption costing net operating income $ 120,000
Fixed mfg. overhead $150,000

= = $6.00 per unit
Units produced 25,000 units
5-19

We can reconcile the difference between absorption
and variable net operating income as follows:
Variable costing net operating income $ 260,000
Deduct: Fixed manufacturing overhead
costs released from inventory
(5,000 units × $6 per unit) 30,000
Absorption costing net operating income $ 230,000
Fixed mfg. overhead $150,000

= = $6.00 per unit
Units produced 25,000 units
5-20

Variable Costing: Years 1 and 2
5-21
Summary of Key Insights
NOI = net operating income

Variable vs. Absorption Costing

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Variable vs. Absorption Costing

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Variable vs Absorption

Explain how variable costing differs

Overview of Absorption and

Fixed Manufacturing Overhead

Unit Cost Computations

Unit Cost Computations

Selling and administrative expenses are

Prepare income statements using both

Now, let’s compute net operating

Extended Comparison of Income

Unit Cost Computations

Since there was no change in the variable costs

These are the 25,000 units

Reconcile variable costing and

Comparing Absorption and

Comparing Absorption and

Fixed mfg. overhead $150,000

Comparing Absorption and

Fixed mfg. overhead $150,000

Comparing Absorption and

Summary of Key Insights

NOI = net operating income

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