Accounting 654 – Chapter 7

Overview of Absorption and Variable Costing:

1) Absorption costing

a) Full costing

b) Product costing

2) Variable costing

a) Direct or marginal costing

b) Includes only variable product costs: DL, DM, and variable manufacturing overhead (VMOH)

c) Excludes fixed manufacturing overhead (FMOH)

Income Comparison of Absorption and Variable Costing:

1) Under absorption costing FMOH is deferred in inventory

2) Under variable costing FMOH is expensed as a period cost

3) In the long-run, income is not affected

4) In the short-run, income is affected, fluctuating from period to period

Effect of Changes in Production on Net Operating Income:

1) With variable costing, net operating income is not affected

2) With absorption costing, net operating income is affected

Choosing a Costing Method:

1) The impact on the manager

2) CVP analysis and absorption costing

3) External reporting and income taxes

4) Advantages of variable costing and the contribution approach

a) Data required for CVP analysis can be taken directly from a contribution martin format income statement (IS)

b) Profit for a period is not affected by changes in inventories

c) Under variable costing, unit product costs do not contain fixed costs

d) The total amount of fixed costs appears explicitly on the IS

e) Variable costing data make it easier to estimate the profitability of products, customers, and other segments of the business. With absorption costing, fixed costs must be arbitrarily allocated to divisions

f) Variable costing ties in with common cost control methods

g) Variable costing net income is closer to net cash flow