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RSM222H1 (43)
Chapter 8

Chapter 8- rsm222.docx

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Rotman Commerce
Donna Losell

Chapter 8: Variable costing: A tool for management  2 approaches for costing products for the purposes of valuing inventories and COGS o Absorption costing: used for external reports o Variable costing: preferred for internal decision making sometimes and must be used when an IS is prepared in contribution format  Produce diff figures for operating income [OVERVIEW OF ABSORPTION & VARIABLE COST]  Variable costing focuses on cost behaviour, clearly separating fixed from variable costs o Strength is that it harmonizes w both the contribution approach and CVP concepts discussed Absorption Costing  Treats all manu costs as product costs, regardless if they are variable or fixed  Cost of a unit of product consists of DM, DL, and both var and fixed MO  Allocates a portion of fixed MO cost to each unit of product, along w var manu costs  Referred to as full costing Variable Costing  Method that includes only var manu costs- DM, DL, and var MO- in the cost of a unit of product o Fixed MO is not treated as a product cost under this method but as a period cost and is expensed in its entirety against rev each period  A cost of unit in inv or COGS does not contain any fixed overhead cost  Referred to sometimes as direct costing or marginal costing Selling and Admin Expense  Are always treated as period costs (exps) and deducted from revs as incurred Unit cost computations  Under absorption costing: all manu costs, variable and fixed, are included when determining the unit product cost  Under variable costing: only the variable manu costs are included in product costs [INCOME COMPARISON OF ABSORPTION AND VARIABLE COSTING] 1. Fixed MO cost deferred in inventory: the portion of the fixed MO cost of a period that goes into inv under the abs costing as a result of production exceeding sales 2. Under variable costing, the entire sum in fixed MOC has been treated as an exp of the current period (including the “deferred” inv) 3. The EI under the variable costing is lower than it is under abs costing; reason is that under var costing only the var manu costs are assigned to units of product and therefore included in inv a. The diff in EIs explains the diff in operating income reported btwn the 2 costing methods 4. Abs costing IS makes no distinction between fixed and var costs; therefore not good for CVP analysis 5. The var costing approach to costing units of product blends very well w the contribution approach to the IS, since both concepts are based on the idea of classifying costs by behaviour  The diff btwn abs costing and var costing centres on timing  Var costing: fixed manu costs should be expensed immediately in total  Abs costing: fixed manu costs should be charged against revs bit by bit as fixed costs being inventoried and carried forward as assets to the next period [EXTENDED COMPARISON OF INCOME DATA]  The change in inventories during the year is the key to understanding how abs costing differs from var costing o When inventories increase the abs costing operating income exceeds the var costing operating income (and vice versa) o If there is no change in inventories then there is no diff in operating income btwn the 2 methods – why?  The only diff that can exist btwn the 2 operating incomes is the amount of fixed MO reco as exp on the IS; when production = sales (no change in inventories), all the fixed MO incurred during the year flows through to the IS as exp  When production exceeds sales the operating income will be greater under abs costing bc part of the fixed MO costs of the current period is deferred in inventory  Under var costing all of the fixed MO costs are expensed  When production less than sales, the operating income reported under abs costing is less bc as inventories are drawn down, the fixed MOCs that were previouslt deferred in inv under abs costing are released and charged against income (fixed MO cost released from inv: the portion of MOC of prior period that becomes an exp of the current period under abs costing as a result of sales > production)
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