ACYMANS: Absorption and Variable Costing

Absorption Costing

A costing method that includes all manufacturing costs (direct materials, direct labor, variable and fixed factory overhead) in the cost of a unit of product. It treats fixed factory overhead as a product cost. It is also known as Full Costing

Variable Costing

A costing method that includes only variable manufacturing costs (direct materials, direct labor and variable manufacturing overhead) in the cost of a unit of product. It treats fixed factory overhead as a period cost. It is also known as Direct Costing.

Throughput Costing

A costing method that includes only direct materials in the cost of a unit of product. It treats everything else as period costs.

Product Costs (or Manufacturing Costs)

Include all costs incurred to produce the physical product.

Direct Materials

Major material inputs that can be physically and conveniently traced directly to the final product.

Direct Labor

The cost of labor that can be physically and conveniently traced to the final product.

Manufacturing Overhead

Includes all costs other than direct materials and direct labor that must be incurred to manufacture a product.

Period Costs (or Nonmanufacturing Costs)

All other costs incurred not related to the production of the physical product.

Marketing or Selling Costs

Costs necessary to get the order and deliver the product.

General and Administrative Costs

All executive, organizational and clerical costs.

Manufacturing Costs - Absorption Costing

Direct Materials + Direct Labor + Variable OH + Fixed OH

Manufacturing Costs - Variable Costing

Direct Materials + Direct Labor + Variable OH

Manufacturing Costs - Throughput Costing

The only manufacturing cost: Direct Materials

Absorption Costing

Rationale: All manufacturing costs - variable and fixed - are necessary ingredients for production to take place and should not be ignored in determining product cost.

Variable costing

Rationale: Fixed factory overhead is incurred in order to have the capacity to produce units in a given period. These costs are incurred whether or not the capacity is actually used to make output. These costs have no future service potential and should be charged against the period and not included in the product cost.

Absorption Costing

This costing is consistent with accounting standards. This method is acceptable for financial reporting and tax purposes.

Variable Costing

This costing violates the matching principle (accounting principle that calls for the recognition of expense by matching it with the related revenue in the same accounting period). This is not acceptable for financial reporting and tax purposes.

Absorption Costing

In this costing approach, fixed factory overhead is considered as a product cost. The peso amount of inventory is always greater than that of variable costing.

Variable Costing

In this costing approach, fixed factory overhead is treated as a period cost. The peso amount of inventory under this approach is always lesser than that of absorption costing.

Absorption Costing

In terms of the presentation of the income statement, this costing approach distinguishes between production and other costs. Production costs pertaining to sold units are first deducted from sales to arrive at gross profit, and then other costs are deducted to obtain net income.

Variable Costing

In terms of the presentation of the income statement, this costing approach distinguishes between variable and fixed costs. All variable costs are first deducted from revenue to arrive at the contribution margin, and then fixed costs are deducted to obtain profit.

True

(True or False) Variable costing income may differ from absorption costing income because of the difference in the amount of fixed factory overhead recognized as expense during an accounting period. This is actually caused by the difference between production and sales volume.

Variable Costing

In this costing approach, problems involved in allocating fixed costs are eliminated.

Variable Costing

This costing approach is more compatible with the standard cost accounting system and provides information for pricing decisions and other decision-making problems encountered.

Variable Costing

In this costing approach, inventory costs and other related accounts, such as working capital, current ratio, and acid test ratio are understated because of the exclusion of fixed factory overhead.

Production = Sales

There is no change in inventory. FFOH under AC is equal to FFOH under VC.

Production > Sales

There is an increase in inventory. FFOH expensed under AC is less than that under VC. AC income is greater than VC income.

Production < Sales

There is a decrease in inventory. FFOH expensed under AC is greater than that of variable costing. Thus, AC income is less than VC income.

Difference in Income (To Reconcile AC and VC)

Change in Inventory (Difference between production and sales) x FFOH Rate