Variable And Absorbtion Cost

Chapter Overview A. Overview of Variable and Absorption Costing. At least two methods can be used in manufacturing companies to value units of product for accounting purposes—absorption costing and variable costing. These methods differ only in how they treat fixed manufacturing overhead costs. Variable Costing. Variable costing includes only variable production costs in product costs. Direct materials, direct labor and variable manufacturing overhead costs would ordinarily be included in product costs under variable costing. Fixed manufacturing overhead is not treated as a product cost under this method. Rather, fixed manufacturing overhead is treated as a period cost and is charged against income each period. Absorption Costing. Absorption costing treats all production costs as product costs, regardless of whether they are variable or fixed. Under absorption costing, a portion of fixed manufacturing overhead is allocated to each unit of product. B. Comparison of Absorption and Variable Costing. When comparing absorption costing and variable costing income statements, a number of points should be noted: Deferral of fixed manufacturing costs under absorption costing. Under absorption costing, if inventories increase then a portion of the fixed manufacturing overhead costs of the current period is deferred to future periods in the inventory account. When the units are later taken out of inventory and sold, the deferred fixed costs flow through to the income statement as part of cost of goods sold. Differences in inventories under the two methods. The ending inventory figures under the variable costing and absorption costing methods are different. Under variable costing, only the variable manufacturing costs are included in inventory. Under absorption costing, both variable and fixed manufacturing costs are included in inventory. 3.Suitability for CVP analysis. An absorption costing income statement is not well suited for providing data for CVP computations since it makes no distinction between fixed and variable costs. In contrast, the variable costing method classifies costs by behavior and is very useful in setting-up CVP computations. C. Extended Comparison of Income Data. Exhibit 7-3 in the text presents a comparison of absorption costing and variable costing income statements over three years in which production is constant but sales vary. Exhibit 7-6 in the text also presents comparative income statements over three years but holds annual sales constant and varies annual production.