ACCTG 42 Module 3

03 MANAGEMENT ADVISORY SERVICES: VARIABLE & ABSORPTION COSTING
ABSORPTION COSTING (FULL/CONVENTIONAL/TRADITIONAL COSTING)

 A product costing method that includes all the manufacturing cost (direct materials, direct
labor, and both the variable and fixed factory overhead) in the product cost
VARIABLE COSTING (DIRECT COSTING)
 A product costing method that includes only variable manufacturing cost in the product (direct
materials, direct labor and variable overhead)
COMPARISON BETWEEN ABSORPTION COSTING (AC) AND VARIABLE COSTING (VC)

Cost Absorption Variable
Direct Material Product Cost Product Cost
Direct Labor Product Cost Product Cost
Variable Overhead Product Cost Product Cost
Fixed Overhead Product Cost Period Cost
Variable Selling and Administrative Period Cost Period Cost
Fixed Selling and Administrative Period Cost Period Cost
Formulas
Sales = Quantity sold x Unit sales price
Variable costs of goods sold = Quantity sold x Unit variable costs
Variable cost of goods manufactures = Quantity produced x Unit variable costs
Variable expenses = Quantity sold x unit variable expenses
Unit Fixed Overhead = Budgeted Fixed Overhead / Normal Capacity
Unit Fixed Expenses = Budgeted Fixed Expenses / Normal Capacity*
Note: *For strategic purposes
Absorption Costing vs. Variable Costing Income Statement
Absorption Costing Variable Costing

Sales xx Sales xx
COGS (Production Cost)* (xx) Variable Cost (xx)
Gross margin xx Contribution margin xx
Operating Expenses (xx) Fixed Cost (xx)
Income (loss) ** xx Income (loss) *** xx
Note: *COGS (Variable and Fixed Production cost)
Differences in Net Income under Absorption and Variable Costing
Case A Case B Case C

If: Production = Sales Production > Sales Production < Sales
Then AC NI = VC NI AC NI > VC NI AC NI < VC NI
, Beg. Invty = End invty Beg. Invty< End invty Beg. Invty> End invty
No change in inventory Increase in inventory Decrease in inventory
Reconciliation of Absorption and Variable Costing Income

Difference (Change) in net income
 (Production – Sales) x Fixed FOH rate per unit
 (Change in inventory) x Fixed FOH rate per unit
 Fixed FOH in beg. Invty – Fixed FOH in end invty.
STRAIGHT PROBLEM 1
Lee Company, which has only one product, has provided the following data concerning its most recent month of
operations:
Selling price ............................

P95

Units in beginning inventory ............. 100
Units produced ........................... 6,200
Units sold ........................ ....... 5,900
Units in ending inventory ................ 400
Variable costs per unit:

Direct materials ....................... P42
Direct labor ........................... 28
Variable manufacturing overhead ........ 1
Variable selling and administrative .... 5
Fixed costs:
Fixed manufacturing overhead ........... P62,000
Fixed selling and administrative ........ 35,400
The company produces the same number of units every month, although the sales in units vary from month to month. The
company's variable costs per unit and total fixed costs have been constant from month to month.
Required:
a. What is the unit product cost for the month under variable costing?
b. What is the unit product cost for the month under absorption costing?
c. Prepare an income statement for the month using the contribution format and the variable costing method.
d. Prepare an income statement for the month using the absorption costing method.
e. Reconcile the variable costing and absorption costing net incomes for the month.
Suggested Solution:
a. & b. Unit product costs
Variable costing:

Direct labor ........................... 28
Unit product cost ...................... P71
Absorption costing:
Direct labor ........................... 28
Fixed manufacturing overhead ........... 10
Unit product cost ...................... P81
c. & d. Income statements
Variable costing income statement

Sales ...................................... P560,500
Less variable expenses:
Variable cost of goods sold:
Beginning inventory .................... P 7,100
Add variable manufacturing costs ....... 440,200
Goods available for sale ............... 447,300
Less ending inventory .................. 28,400
Variable cost of goods sold ............ 418,900
Variable selling and administrative .... 29,500 448,400
Contribution margin ........................ 112,100
Less fixed expenses:

Fixed manufacturing overhead ........... 62,000
Fixed selling and administrative ....... 35,400 97,400
Net income ................................. P 14,700
Absorption costing income statement

Sales ...................................... P560,500
Cost of goods sold:
Beginning inventory ...................... P 8,100
Add cost of goods manufactured ........... 502,200
Goods available for sale ................. 510,300
Less ending inventory .................... 32,400 477,900
Gross margin ............................... 82,600

Less selling and administrative expenses:
Variable selling and administrative ...... 29,500
Fixed selling and administrative ......... 35,400 64,900
Net income ................................. P 17,700
e. Reconciliation
Variable costing net income ................ P14,700
Add fixed manufacturing overhead costs
deferred in inventory under absorption
costing .................................. 3,000
Deduct fixed manufacturing overhead costs
released from inventory under absorption
costing .................................. 0
Absorption costing net income .............. P17,700
STRAIGHT PROBLEM 2 (Inventory Cost)
The following information is available for Blite Corporation’s new product line:
Sales price per unit P60

Variable manufacturing cost per unit of production 30
Total fixed manufacturing costs 50,000
Variable administrative cost per unit of production 6
Total fixed selling and administrative expenses per year 30,000
Normal capacity is 10,000 units. During the year, 10,000 units were produced, of which 2,000 units were not sold. There
was no inventory at the beginning of the year.
Required:
1. Cost of ending inventory assuming the use of variable costing
2. Cost of ending inventory assuming the use of absorption costing
3. Total variable costs charged to expense for the year, assuming the use of variable costing
4. Total fixed costs charged to expense for the year, assuming the use of absorption costing
SOLUTION GUIDE
1 2 3 4
STRAIGHT PROBLEM 3 (Operating Income)
Emil Company started commercial operation on January 1, 2018. It produces a single product that sells for P50 per unit.
Emil uses an actual (historical) cost accounting system. Normal capacity of the company is 50,000 units. Units in
beginning inventory is 5,000
For 2018, the following costs and expenses were incurred:

Fixed Variable Costs
Costs
Materials - P20.00 per unit produced
Labor - 10.00 per unit produced
Factory overhead P300,000 5.00 per unit produced
Selling and administrative expenses 150,000 1.00 per unit sold
Required: Compute for the operating income for 2018 under absorption costing and variable costing using the following
independent cases
Production Sales
A. 50,000 48,000
B. 50,000 53,000
C. 50,000 50,000
D. 53,000 58,000
E. 48,000 45,000
SOLUTION GUIDE
A B C
ABSORPTION VARIABLE ABSORPTION VARIABLE ABSORPTION VARIABLE

SALES
Var. Cost
Fixed cost
Var. Exp.
Fixed exp.
Profit (loss)
D E
ABSORPTION VARIABLE ABSORPTION VARIABLE

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03 MANAGEMENT ADVISORY SERVICES: VARIABLE & ABSORPTION COSTING

ABSORPTION COSTING (FULL/CONVENTIONAL/TRADITIONAL COSTING)

COMPARISON BETWEEN ABSORPTION COSTING (AC) AND VARIABLE COSTING (VC)

Absorption Costing vs. Variable Costing Income Statement

Absorption Costing Variable Costing

Differences in Net Income under Absorption and Variable Costing

Case A Case B Case C

Reconciliation of Absorption and Variable Costing Income

Selling price ............................

Variable costs per unit:

a. & b. Unit product costs

Direct materials ....................... P42

c. & d. Income statements

Variable costing income statement

Less fixed expenses:

Absorption costing income statement

Gross margin ............................... 82,600

STRAIGHT PROBLEM 2 (Inventory Cost)

Sales price per unit P60

For 2018, the following costs and expenses were incurred:

ABSORPTION VARIABLE ABSORPTION VARIABLE ABSORPTION VARIABLE

ABSORPTION VARIABLE ABSORPTION VARIABLE

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