Income Effects of Alternative Stock-Costing Methods

Flashcards covering the key differences between variable costing and absorption costing.

Variable Costing

An alternative costing system where only variable manufacturing costs are assigned to products and fixed manufacturing costs are treated as period costs.

Absorption Costing

A costing system where all manufacturing costs (both variable and fixed) are assigned to products.

Full Costing System

Also known as absorption costing, this system allocates all manufacturing costs to products/services to value unsold inventories at the total cost of manufacture.

Period Costs

Costs that are not assigned to products but are charged directly to the profit statement (e.g., fixed manufacturing costs under variable costing).

Product Cost

Costs associated with the production of goods, included in inventory valuation (e.g., variable manufacturing costs under variable costing).

Direct Costs

Costs that can be directly traced to a cost object.

Indirect Costs

Costs that cannot be directly traced to a cost object and are allocated using an allocation base.

Variable Costs

Costs that change in proportion to the level of production or sales.

Fixed Costs

Costs that do not change with the level of production or sales within a relevant range.

Contribution Margin

The difference between revenues and variable costs; used in variable costing income statements.

Gross Margin

The difference between revenues and cost of goods sold; used in absorption costing income statements.

Absorption Costing vs. Variable Costing

Absorption costing includes fixed manufacturing costs in inventoriable costs, while variable costing treats them as period costs.

Effects of Stock Levels on Operating Profit

When stock levels increase, variable costing reports less operating profit than absorption costing; when stock levels decrease, variable costing reports more operating profit.