ACC 406 Lecture Notes - Total Absorption Costing, Fixed Cost, Income Statement

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Difference between variable and absorption costing depends on fixed factory overhead. Absorption costing assigns all manufacturing costs to the product. Fixed overhead is viewed as product cost, not period cost. Variable cost assigns only variable manufacturing costs to product: direct materials, direct labor and variable overhead. 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. If product > sales then absorption income > variable income. If product < sales then absorption income < variable income. If product = sales then absorption income = variable income.

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