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Lecture 9

COMMERCE 2AB3 Lecture Notes - Lecture 9: Cost Accounting, Earnings Before Interest And Taxes, Financial Statement


Department
Commerce
Course Code
COMMERCE 2AB3
Professor
Mohamed Shehata
Lecture
9

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Chapter 9
ABSORPTION AND VARIABLE COSTING SYSTEMES
Period vs. Product Costs
The terms "product cost" and "period cost" are used to describe the timing with which
expenses are recognized.
Productcostsarethecostsassignedtogoodsmanufactured.Thesecostsareinventoried
untilthegoodsaresold.Intheperiodofthesale,theproductcostsarerecognizedasan
expensecalledcostofgoodssold.
Periodcostsareallcoststhatarenotproductcosts.Thesecostsarenotinventoriedbutare
expensedintheperiodtheyareincurred.
Methods(ApproachesorSystems)ofProductCosting:
There are two, commonly used methods (approached or systems) for determining product costs and
reporting income in a manufacturing firm: (i) Absorption Costing system and (ii) Variable Costing
System.
Absorption Costing System
A system of accounting for costs in which ALL manufacturing costs ( DM, DL, Variable FOH and
Fixed FOH) are assigned to Work-in-Process account as a product cost. When the manufactured
goods are finished, these product costs flow from Work-in-Process Inventory into Finished-Goods
Inventory. Finally, during the accounting period when the goods are sold, the product costs flow
from Finished-Goods Inventory into Cost of Goods Sold, an expense account.
Variable Costing System
A system of cost accounting that assigns ONLY variable manufacturing costs ( DM, DL, and
Variable FOH) to products. Fixed FOH costs are treated as period costs, where they are expensed
in the period during which they are incurred.
NOTICE that the only difference between absorption and variable costing is that fixed costs are
included as product costs in absorption costing; however, under variable costing system fixed
overhead is expensed immediately, as it is incurred.
The absorption costing method is required by GAAP for the purpose of preparing financial
statements for external users, while variable costing method is used for the purpose of
preparing financial statements for managers to make decisions.
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Absorption Costing System
WIP FG Income Statement
________________________ _____________________ __________________
BB BB Sales Rev.
DM CGM CGM CGS (-) CGS
DL Gross P.
VFOH (-) V. S&A
FFOH (-) F. S&A
EB EB Op. Income
Variable Costing System
WIP FG Income Statement
________________________ _____________________ ___________________
BB BB Sales Rev.
DM CGM CGM CGS (-) CGS
DL (-) V. S&A
VFOH
Contribution Margin
(-) FFOH
EB EB (-) F. S&A
Op. Income
CLASSIFICATION OF COSTS UNDER VARIABLE AND ABSORPTION COSTING
vmc
vmc
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