Chapter six - Absorption versus variable costing

Absorption Costing?

treats all manufacturing costs as product costs, regardless of whether they are variable or fixed.

What product costs does Absorption Costing include?

includes direct materials, direct labor, and both variable and fixed manufacturing overhead

Variable Costing?

Treats manufacturing costs that vary with output as product costs → treats fixed moh as period costs

What type of costs does Variable Costing include?

direct materials, direct labor, and the variable portion of manufacturing overhead.

How is fixed manufacturing overhead cost treated under Variable Costing?

Only fixed manufacturing overhead is treated as a period cost and, like selling and administrative expenses, it is reported as an expense on income statement in its entirety each period

How is fixed manufacturing overhead cost treated under Absorption Costing?

It is allocated as a portion of fixed manufacturing overhead cost to each unit of product.

Main differences between absorption costing and variable costing

• In absorption costing fixed manufacturing overhead costs are treated as product costs and included in work in process inventory.

• In variable costing fixed manufacturing overhead costs are treated as period costs and expensed in full each period.

What is a Traditional Income Statement?

A financial statement that organizes revenues and expenses by function, typically showing gross profit, operating income, and net income → Used for external use

What is a Contribution Margin Income Statement?

a management accounting tool that organizes costs by behavior (variable vs. fixed) rather than function. It shows how sales revenue contributes to covering fixed costs and generating profit, and is used for internal decision-making.

How are costs classified in a Traditional Income Statement?

By function — product costs (COGS) and period costs (operating expenses).

How are costs classified in a Contribution Margin Income Statement?

By behavior — variable costs and fixed costs.

How to find Fixed manufacturing overhead deferred from inventory?

Fixed manufacturing overhead in ending inventories - Fixed manufacturing overhead in beginning inventories

How to reconcile the absorption costing net operating income?

Absorption costing net operating income(loss) = Variable Costing net operating income (loss) - Fixed Manufacturing overhead deferred in inventories