10/11/2022

Variable and Absorption

Costing
Module 4

Intended Learning Outcomes

• Explain Variable costing and Absorption costing

• Apply the techniques in reconciling the operating income under

variable costing and absorption costing

• Compute the inventory values between the two methods

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Introduction
• Income is one of the many important measures used to evaluate the
performance of both segments and the company as a whole.

• Cost accounting is used to determine product costs by adding all

manufacturing costs as inventoriable costs and charged to revenues
when sold as “cost of goods sold” under the absorption (full) costing
method.

• Absorption costing method costs the products with all manufacturing

costs regardless of whether the manufacturing costs are variable or
fixed.

Income Statement
Traditional Format Variable Costing Format

Sales xx Sales xx

Less: Cost of Goods Sold xx Less: Variable Costs xx

Gross Income xx Gross Income xx

Less: Operating Expense xx Less: Fixed Costs xx

Income (Loss) xx Income (Loss) xx

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Traditional/Conventional Income
Statement
• Costs are presented according to function.
• Cost of goods sold
• Operating expenses

Variable Costing Income Statement

• Highlights cost behavior patterns and classified costs
according to behavior:
• Variable costs
• Fixed costs

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Absorption Costing
• Also called as full or conventional costing
• Product costs – direct materials, direct labor, and all factory overhead
costs

Variable (Direct) Costing

• Variable costing recognizes that the cost of the product must include
only those production costs that vary directly with the volume of
product.

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Comparison of Variable and

Absorption Costing
Difference Absorption Costing Variable Costing
Cost Segregation Cost are segregated Cost are segregated
according to function according to behavior
Cost of inventories Variable and fixed Variable
manufacturing costs manufacturing costs

Note: The cost of inventories under absorption costing is always

higher than the cost of inventories under variable costing because the
former includes fixed overhead cost, which is not part of the product
cost in the latter method.

Comparison of Variable and

Absorption Costing
Difference Absorption Costing Variable Costing
Treatment of Fixed Product Cost Period Cost
Factory Overhead
Income Statement Manufacturing costs are Variable costs are
distinguished from distinguished from fixed
nonmanufacturing costs. costs.
Amount of Income Equal to, higher, or Equal to, higher, or
lower than income lower than income
under variable costing under absorption
depending on costing depending on
production and sales production and sales

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Comparison of Product Cost and

Period Cost
PRODUCT COST PERIOD COST
Allocated between sold and unsold Charged against current revenue
units or treated as expense without
regard to production and sales
Cost allocated to the unsold units Non-inventoriable cost
becomes part of the cost of
inventory
Current income is diminished by Decreases income for the current
that portion of the cost allocated period for its full amount.
to the units sold during the period.

Product Cost and Period Cost for

Absorption and Variable Costing
Absorption Variable
Product Cost

Direct Material Direct Material

Product Cost

Direct Labor Manufacturing Direct Labor

Costs
Variable FOH Variable FOH
Fixed FOH Fixed FOH
Period Cost

Variable & Fixed Variable & Fixed

Period Cost

Selling Expense Operating Selling Expense

Variable & Fixed Costs Variable & Fixed
Administrative Administrative
Expense Expense

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Problem Solving
Flower Manufacturing Corp. produces and sells earphones. Its production, sales and cost data for
a three-year period are shown below:
Year 1 Year 2 Year 3 Required:
Manufacturing Costs Assuming that Flower
Materials (per unit) 3.00 3.00 3.00 Manufacturing
Labor (per unit) 2.00 2.00 2.00 Corporation started
commercial
Variable OH (per unit) 1.00 1.00 1.00
operations in year 1,
Fixed OH (Total) 2,000.00 2,000.00 2,000.00 prepare income
Selling and Administrative Costs statements for each
Variable (per unit sold) 1.50 1.50 1.50 year using (1)
Fixed (Total) 800.00 800.00 800.00 absorption costing
and (2) variable
Production (in units) 1000 1000 1000
costing)
Sales (in units) 1000 800 1100
Selling Price (per unit) 15.00 15.00 15.00

Solution
Compute for Product Cost per unit:

Absorption Costing Variable Costing

Direct Materials 3.00 3.00

Direct Labor 2.00 2.00

Variable OH 1.00 1.00

Fixed OH (2,000/1,000 units) 2.00 -

Total (per unit) 8.00 6.00

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Solution
Flower Manufacturing Corporation Flower Manufacturing Corporation
Income Statement Income Statement
Year 1 Year 1

Sales (1,000 units* P15) 15,000 Sales (1,000 units* P15) 15,000.00
Less: Cost of
Goods Sold (1,000 units * P8) 8,000 Less: Variable Costs

Gross Income 7,000 Cost of Goods Sold (1,000 units * P6) 6,000.00
(1,000 units *
Less: Selling and Admin Expenses Selling and Admin P1.50) 1,500.00 7,500.00
(1,000 units *
Variable P1.50) 1,500 Contribution Margin 7,500.00
Fixed 800 2,300 Less: Fixed Costs

Income 4,700 Factory overhead 2,000.00

Selling and Admin 800.00 2,800.00

Income 4,700.00

Production = Sales
• When P = S
• There is no change in inventory
• FOH expensed under absorption = FOH expensed under variable
costing
• Absorption costing income = variable costing income

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Problem Solving
Flower Manufacturing Corp. produces and sells earphones. Its production, sales and cost
data for a three-year period are shown below:
Year 1 Year 2 Year 3 Required:
Manufacturing Costs Assuming that Flower
Materials (per unit) 3.00 3.00 3.00 Manufacturing
Labor (per unit) 2.00 2.00 2.00
Corporation started
commercial operations
Variable OH (per unit) 1.00 1.00 1.00
in year 2, prepare
Fixed OH (Total) 2,000.00 2,000.00 2,000.00 income statements for
Selling and Administrative Costs each year using
(1) absorption costing
Variable (per unit sold) 1.50 1.50 1.50
and
Fixed (Total) 800.00 800.00 800.00 (2) (2) variable costing)
Production (in units) 1000 1000 1000
Sales (in units) 1000 800 1100
Selling Price (per unit) 15.00 15.00 15.00

Solution
Flower Manufacturing Corporation Flower Manufacturing Corporation
Income Statement Income Statement
Year 2 Year 2

Sales (800 units* P15) 12,000 Sales (800 units* P15) 12,000
Less: Cost of Goods Sold Less: Variable Costs

Cost of Goods (1,000 units *

Manufactured P8) 8,000 Cost of Goods Sold
Less: Ending (200 units * Cost of Goods
Inventory P8) 1,600 6,400 Manufactured (1,000 units * P6) 6,000
Less: Ending
Gross Income 5,600 Inventory (200 units * P6) 1,200 4,800

Less: Selling and Admin Expenses Selling and Admin (800 units * P1.50) 1,200 6,000

Variable (800 units * P1.50) 1,200 Contribution Margin 6,000

Fixed 800 2,000 Less: Fixed Costs

Income 3,600 Factory overhead 2,000.00

Selling and Admin 800.00 2,800

Income 3,200

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Production > Sales

• When P > S
• There is an increase in inventory
• FOH expensed under absorption < FOH expensed under variable
costing
• Absorption costing income > variable costing income

Problem Solving
Flower Manufacturing Corp. produces and sells earphones. Its production, sales and cost data
for a three-year period are shown below:
Year 1 Year 2 Year 3
Required:
Manufacturing Costs
Assuming that Flower
Materials (per unit) 3.00 3.00 3.00 Manufacturing
Labor (per unit) 2.00 2.00 2.00 Corporation started
Variable OH (per unit) 1.00 1.00 1.00 commercial operations in
year 3, prepare income
statements for each year
using
Fixed OH (Total) 2,000.00 2,000.00 2,000.00 (1) absorption costing
Selling and Administrative Costs and
Variable (per unit sold) 1.50 1.50 1.50 (2) (2) variable costing)
Fixed (Total) 800.00 800.00 800.00
Production (in units) 1000 1000 1000
Sales (in units) 1000 800 1100
Selling Price (per unit) 15.00 15.00 15.00

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Solution
Flower Manufacturing Corporation Flower Manufacturing Corporation
Income Statement Income Statement
Year 3 Year 3
(1,100 units* Sale (1,100 units*
Sales P15) 16,500 s P15) 16,500
Less: Cost of Goods Sold Less: Variable Costs
Beginning Inventory (200 units * P8) 1,600 Cost of Goods Sold
Cost of Goods Manufactured (1,000 units * P8) 8,000 Beginning Inventory (200 units * P6) 1,200
Cost of Goods Available for Cost of Goods (1,000 units *
Sale 9,600 Manufactured P6) 6,000
Cost of Goods Available for
Less: Ending Inventory (100 units * P8) 800 8,800 Sale 7,200
Gross Income 7,700 Less: Ending Inventory (100 units * P6) 600 6,600
(1,100 units *
Less: Selling and Admin Expenses Selling and Admin P1.50) 1,650 8,250

Variable (1,100 units * P1.50) 1,650 Contribution Margin 8,250

Fixed 800 2,450 Less: Fixed Costs

Income 5,250 Factory overhead 2,000

Selling and Admin 800 2,800

Incom
e 5,450

Production < Sales

• When P < S
• There is a decrease in inventory
• FOH expensed under absorption > FOH expensed under variable
costing
• Absorption costing income < variable costing income

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Accounting for Income Difference

Formulas to compute for Difference in income
• FxOH in BI – FxOH in EI

• (BI – EI) x FxOH per unit

• Changed in Inventory x FxOH per unit

• (P – S) x FxOH per unit

Problem Solving
Flower Manufacturing Corp. produces and sells earphones. Its production, sales and cost data
for a three-year period are shown below:
Year 1 Year 2 Year 3 Required:
Manufacturing Costs Apply the
Materials (per unit) 3.00 3.00 3.00 formulas to
Labor (per unit) 2.00 2.00 2.00 account for the
Variable OH (per unit) 1.00 1.00 1.00 income difference
for Year 2 and 3.
Fixed OH (Total) 2,000.00 2,000.00 2,000.00
Selling and Administrative Costs
Variable (per unit sold) 1.50 1.50 1.50
Fixed (Total) 800.00 800.00 800.00
Production (in units) 1000 1000 1000
Sales (in units) 1000 800 1100
Selling Price (per unit) 15.00 15.00 15.00

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Solution

Year 2 Year 3
Ending Inventory 200 units 100 units
Less: Beginning Inventory 0 200
Increase (decrease) in inventory 200 (100)
X FxOH per unit P2 P2
Diff in income 400 (200)

Alternative Solution
Year 2 Year 3
Production 1,000 units 1,000
Less: Sales 800 1,100
Increase (decrease) in inventory 200 (100)
X FxOH per unit P2 P2
Diff in income 400 (200)

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Reconciliation of Variable Costing and

Absorption Costing

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