Differentiate absorption costing from variable costing

Absorption Costing Variable Costing

Definiton Sometimes called full
costing
Assigns all manufacturing
costs to the product
Use for external Reporting
Formula Absorption-Costing =
Direct Materials+ Direct
Labor + Variable
Overhead+ Fixed
overhead
Product Costs Direct Materials
Direct Labor
Variable Overhead
Fixed overhead
Period Cost Selling Expenses
Administrative expenses
Fixed Overhead Viewed as a product cost
Stresses the difference
between fixed and variable
cost
Assigns only variable
manufacturing cost to the
product
Provide useful insights into
various capacity cost
management decisions
Variable-Costing = Direct
Materials+ Direct Labor +
Direct Materials
Direct Labor
Variable Overhead
Fixed overhead
Selling Expenses
Administrative expenses
Treated as an expense
and excluded from product
cost

Discuss how these costing methods affect net income of the company.
Unit product costs are the basis for cost of goods sold. With that, the variable and
absorption costing methods can lead to different operating income figures. The
difference increases since of the amount of fixed recognized as an expense under two
methods.
Which one is more preferable to use? Justify.
 Using the two methods has its own purpose. When it comes to external reporting,
Absorption costing is more preferable since it was required by the the generally
accepted accounting principles. The Financial Accounting Standards Board, the Internal
Revenue Service and other regulatory bodies do not accept variable costing as product
costing method for external reporting. On the other hand, when it comes to internal
reporting, Variable Costing is more preferable since it can supply vital cost information
for decision making and control which such information is not supplied by Absorption
Costing. Hence, Variable Costing is an important managerial tool.

Materials ($94×20,000) = $1,880,000

Labor ($16×20,000) = 320,000

Variable overhead ($80×20,000) = 1,600,000

Variable selling ($7×20,000) = 140,000

Total additional resource spending= $3,940,000

$3,940,000÷ 20,000 = $ 197

Total unit variable cost $ 197

Garner must accept the order since it would cover total variable costs and it will
increase the income by $15 per unit for a total increase of $300,000.

212-197 =$ 15

2. The correlation coefficients indicate that the reliability of the cost formulas of the
four formulas, overhead activity may be a problem. The percentage coefficient means
that only about that percent of the variability on overhead cost is explained by direct
labor hours. This should have a bearing on the answer to Requirement 1 because if the
percentage is low, there are activity drivers other than direct labor hours that are
affecting variability in overhead cost. What these drivers are and how resource
spending would change need to be known before a sound decision can be made
3.

Material ($94×20,000) = $ 1,880,000

Labor ($16×20,000) = 320,000

Variable overhead:

($85×20,000) = 1,700,000

($5,000×12)= 60,000

($300×600) = 180,000

Variable selling ($7×20,000) = 140,000

Total additional resource spending $ 4,280,000

$ 4,280,000 ÷ 20,000 = $ 214

Total unit variable cost $ 214

The order should not be accepted now because it does not cover the variable
activity costs and unit would lose $2.

$212 – $214 = $2

It would also be useful to know the step-cost functions for any activities that have
resources acquired in advance of usage on a short-term basis. It is possible that there
may not be enough unused activity capacity to handle the special order, and resource
spending may also be affected by a need which, in this case, would be unexpected to
expand activity capacity.