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ACC406 - Chapter 8.docx

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Ryerson University
ACC 406
All Accounting410

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 and production  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. Inventory Valuation 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 performance reports Fixed expenses broken down into two categories: Direct Fixed Expense and Common Fixed expense  Direct Fixed Expenses: directly traceable to a segment. ‘Avoidable fixed expenses’ or ‘traceable fixed expense’ these
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