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Cost Accounting Essay

1865 words - 7 pages

Absorption Costing v Variable Costing

Absorption Costing v Variable Costing

Absorption Costing:

All costs necessary to manufacture a product are "absorbed'" by the product. Product costs include both Fixed and Variable Costs.

This is the method we learned in Job Order and Process Costing (DM, DL, FOH)

This is what is required for GAAP reporting of Inventory on the BS and Cost of Goods Sold on the IS.

It is the proper way to look at things in the long term

Variable Costing (a.k.a. Direct Costing):

Only variable manufacturing costs are included in the product cost reported as cost of goods sold or ending inventory.

These variable manufacturing costs are direct materials, direct labor, and variable overhead (overhead costs that change as production volume increases or decreases).

All fixed costs, including fixed manufacturing overhead, are treated as period expenses.

Useful for controlling costs, pricing products (in the short term), special order situations, analyzing markets and products


The only difference between variable and absorption costing is the treatment of fixed overhead. (Note: the treatment of fixed selling and admin costs are expenses under either method.)

While variable costing is often the most useful system to aid company management in making decisions, it is not allowed for external financial reporting

Trans 1, 2

Prepare an Absorption Costing (GAAP) income statement from data on Trans 1.

Note that CofGS absorbed $300,000 of Fixed Cost and that the remaining $30,000 is deferred as an Inventory asset.

Ending Inventory = 2,000 units x $65 = $130,000

Trans 3

Describe format of a Variable Costing income statement

Sales - Variable COGS = Manufacturing Margin

Manufacturing Margin - Variable Selling & Admin. Expenses = Contribution Margin

Contribution Margin - Fixed Costs = Income from Operations

Note that this is consistent with how we learned the calculation for CM in previous chapter, all we did is add an intermediate subtotal called Manufacturing Margin.

Using info from Trans 17-1 prepare a Variable Costing Income Statement.

Trans 17-2 solution: Contrast operating Income. The difference is that Absorption Costing deferred $30K of fixed cost as Inventory, while Variable Costing expenses ALL Fixed Costs as costs of the period.

They are only different because there was a change in inventory. If beginning and ending inventory would have been unchanged (we produced and sold the same amount) there would not be a difference.

Excel Example "Ch 20 Variable v Absorption Costing Example.xls"

Do E1, E2, (E17-5 could skip)

Inventory and Variable Costing

Question: What is wrong with a company producing too much inventory?

Storage cost, capital invested, risk of damage, theft, obsolescence, property tax

Review Exhibits 5 & 6

These exhibits emphasize the impact on net...

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