CHAPTER 8: ABSORPTION AND V ARIABLE C OSTING ,AND INVENTORY M ANAGEMENT
Variable and Absorption Income Statements
Difference between variable and absorption costing depends on fixed factory overhead
Absorption Costing assigns ALL manufacturing costs to the product. Shows both sales
Fixed overhead is viewed as PRODUCT COST, not period cost
Fixed overhead is an inventoriable cost
Variable Cost assigns only variable manufacturing costs to product: direct materials,
direct labor and variable overhead. Affected only by the level of sale.
Fixed overhead is treated as a PERIOD COST and is excluded from product cost
Rationale is that fixed overhead is a cost of capacity, once period is over any
benefit provided by capacity has expired and should not be inventoried
GAAP and CRA require absorption costing for external reporting. However for internal
application variable costing is an important tool.
Unit product cost under absorption costing is always greater than the unit product cost
under variable costing
Product, Sales, and Income Relationship
If Product > Sales then Absorption Income > Variable Income
If Product < Sales then Absorption Income < Variable Income
If Product = Sales then Absorption Income = Variable Income
Reasons for Using Variable Costing
Absorption-costing income is affected by production volume with variable-costing
income is not.
Sale-oriented company may prefer variable costing because its income is affected by
level of sales.
Product-oriented company might prefer absorption costing because additional production
increases the operating income with absorption costing but not with variable costing
Comparing Variable and Absorption Costing
The Contribution Approach Uses the contribution margin (Sales – Variable Expense) to
look at the difference between the two costing systems. See the impact of changes in
sales demand on operating income.
1 CHAPTER 8: ABSORPTION AND V ARIABLE C OSTING,AND INVENTORY M ANAGEMENT
Gross Margin / Contribution Margin
Gross Margin is used from the absorption approach
Contribution Margin is used from the variable approach
Production volume variance =
(Actual volume – Expected Volume) x Fixed Overhead Rate
Segmented Income Statement Using Variable Costing
Segment subunit of a company of sufficient importance to warrant the production of
Fixed expenses broken down into two categories: Direct Fixed Expense and Common
Direct Fixed Expenses: directly traceable to a segment. ‘Avoidable fixed expenses’
or ‘traceable fixed expense’ these