Chapter 19: Variable and Absorption Costing
Introduction
Discussion of two main product costing methods in managerial accounting: Variable Costing and Absorption Costing.
Costing Methods
Variable Costing
Comprises the following components:
Direct Materials
Direct Labor
Variable Overhead
Absorption Costing a.k.a Full Costing
Includes the following components:
Direct Materials
Direct Labor
Variable Overhead
Fixed Overhead
GAAP Requirements:
Absorption costing is mandated by Generally Accepted Accounting Principles (GAAP) for external financial reporting.
Its use can sometimes lead to misleading product cost information, which may result in poor managerial decisions.
Learning Objectives
Learning Objective P1: Compute Unit Cost under Both Absorption and Variable Costing
Examination of how to calculate the unit cost in both methods as demonstrated in various exhibits throughout the chapter.
Reference to Exhibits (e.g., Exhibits 19.1, 19.2, 19.3)
Income Reporting
Learning Objective P2: Prepare and Analyze Income Statements
Key details include:
Preparing income statements that highlight differences between absorption and variable costing.
Scenarios in Income Reporting
Units Produced = Units Sold
Income Statement analysis for equal production and sales volume illustrated in Exhibit 19.4.
Units Produced > Units Sold
Absorption higher profit
Scenario analysis showing how absorption costing yields a higher profit when production exceeds sales, illustrated in Exhibit 19.5.
Units Produced < Units Sold
Variable Higher Profit
When more units are sold than produced, variable costing results in a higher profit; illustrated in Exhibit 19.6.
Summarizing Income Reporting
Exhibit 19.7 is referenced for summarizing the consequences of absorption versus variable costing on income.
SEE NOTES FOR EXAM HINT
Planning Production
Learning Objective C1: Describe Overproduction Implications of Absorption Costing
Absorption costing can incentivize overproduction as it spreads fixed costs over more units, potentially leading to inventory buildup.
Exhibits 19.8, 19.9, and 19.10 illustrate income implications under absorption and variable costing.
Pricing Decisions
Learning Objective P3: Determine Product Selling Price and Analyze Special Orders
Three-Step Process to Determine Selling Price:
Determine Product Cost Per Unit using absorption costing.
Determine Target Markup on the product cost per unit.
Calculate Target Selling Price by adding the markup to the cost.
Illustrated in Exhibit 19.11.
Fixed and Variable Cost Considerations:
Emphasis on covering all fixed and variable costs in long-term pricing strategies.
Short-term acceptance of special orders if the price offered exceeds variable costs highlighted.
The analysis is further detailed in Exhibit 19.12.
Variable Costing for Services
The relevance of variable costing in service industries is discussed, highlighting its implications on pricing decisions as noted in Exhibit 19.13.
Contribution Margin Analysis
Learning Objective A1: Apply Contribution Margin Ratio for Business Decisions
Contribution Margin Ratio: Defined as the percent of total sales that remains after subtracting variable expenses.
Importance in various business scenarios emphasized in Exhibit 19.15.
Contribution Margin by Product Line:
Impact on managerial decisions including:
Increasing the selling price per unit.
Decreasing variable costs of goods sold per unit.
Increasing sales efforts to enhance profitability.
Displayed in Exhibit 19.16.
Appendix: Converting Income under Variable to Absorption Costing
Learning Objective A2: Convert Income Measurements
Companies must adopt absorption costing methods for external and tax reporting purposes.
Formula for converting income under variable costing to absorption costing is highlighted in Exhibits 19A.1 & 19A.2.
Noted as an essential process in reporting and financial accuracy adjustments.