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Managerial Accounting Chapter Eight Notes

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ACCT 2230
Elliot Currie

Chapter Eight Variable Costing A Tool for Managementy Overview of Absorption and Variable Cost o Absorption CostingAbsorption costing treats all manufacturing costs as product costs regardless of whether they are variable or fixed The cost of a unit of product under the absorption costing method therefore consists of direct materials direct labour and both variable and fixed overhead Thus absorption costing allocates a portion of fixed manufacturing overhead cost to each unit of product along with the variable manufacturing costs Because absorption costing includes all manufacturing costs as product costs it is frequently referred to as the full cost methodo Variable CostingVariable costing only those manufacturing costs that vary with output are treated as product costs This would generally include direct materials direct labour and the variable portion of manufacturing overhead Fixed manufacturing overhead is not treated as a product cost under this method Fixed manufacturing overhead is treated as a period cost and like selling and administrative expenses it is charged off in its entirely against revenue each period Variable costing is sometimes referred to as direct costing or marginal costingo Unit Cost ComputationsUnder the absorption costing method all manufacturing costs variable and fixed are included when determining the unit product cost Under the variable costing method only the variable manufacturing costs are included in product costsy Income Comparison of Absorption and Variable Costing o Several points can be made about financial statementsUnder the absorption costing method if there is an ending inventory the fixed manufacturing costs associated with the inventory will be carried forward as a balance sheet account inventory rather than being treated as a period cost Such a deferral of costs is known as fixed manufacturing overhead cost deferred in inventory Under the variable costing method the entire fixed manufacturing overhead costs has been treated as an expense of the current period The ending inventory figure under the variable costing method is lower than it is under the absorption costing method The reason is that under variable costing only the variable manufacturing costs are assigned to units of product and therefore included in inventory The absorption costing income statement makes no distinction between fixed and variable costs therefore it is not well suited for CVP computations which are important for good planning and control To generate data for CVP analysis it would be necessary to spend time reworking and reclassifying costs on the absorption statement The variable costing approach is costing units of product blends very well with the contribution approach to the income statement since both concepts are based on the idea of classifying costs by behaviouro The difference between the absorption costing method and the variable costing method centres on timing Advocates of variable costing say that fixed manufacturing costs should be expensed immediately in total whereas advocates of absorption costing say that fixed manufacturing costs should be charged against revenues bit by bit as units of product are soldy Extended Comparison of Income Data
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