Managament Accounting SM 1 W 5

This set of vocabulary flashcards summarizes the differences, income statement structures, and decision-making applications of absorption versus variable costing based on the Week 5 lecture notes.

Absorption costing

Also called full costing, this method includes all manufacturing costs (direct materials, direct labour, variable manufacturing overhead, and fixed manufacturing overhead) in the product cost.

Variable costing

Also called direct costing or marginal costing, this method includes only variable manufacturing costs (direct materials, direct labour, and variable manufacturing overhead) in the product cost.

Fixed Manufacturing Overhead (Treatment)

The key difference between systems; absorption costing treats it as a product cost, while variable costing treats it as a period cost.

Selling and administrative costs

Costs that are always treated as period costs under both absorption and variable costing systems.

Gross Profit

The result of subtracting the Cost of Sales from Revenue in an absorption costing income statement.

Contribution Margin

The result of subtracting variable costs from sales revenue in a variable costing income statement, useful for decision-making.

Production > Sales

A situation where absorption costing profit is higher than variable costing profit because fixed overhead is stored in closing inventory.

Sales > Production

A situation where variable costing profit is higher than absorption costing profit because fixed overhead is released from inventory.

Production = Sales

A situation where the operating profit is the same under both absorption and variable costing methods.

CVP analysis

A management tool that is best supported by variable costing because it clarifies the impact of fixed costs and shows contribution margin.

External Financial Reporting

The specific purpose for which absorption costing is required, as it recognises all production costs and helps value inventory for official statements.

Inventory Valuation (Best Method)

Absorption costing is considered the better method for this purpose as it includes a share of fixed manufacturing overhead as an asset.