STRATEGIC COST MANAGEMENT
Lesson to Research:
OUTLINE TOPIC:
1. Variable Costing and Absorption Costing
2. Advantages and Diasdavantages of Variable Costing
3. Comparison between Variable and Absorption Costing
4. Reconciliation of Net Income Under Variable and Absorption Costing
5. Conversion of I/S from variable to Absorption Costing
OBJECTIVE:
1. Explain the meaning of Variable and Absorption Costing.
2. Describe the advantages and disadvantages of Variable and Absortion
Costing.
3. Compare Variable Costing with Absorption Costing.
4. Explain the difference in Net Income under Avariable and Absorption
Costing.
5. Explain why managers prefer variable costing to absorption costing
LEARNING OUTCOME:
1. Understand the difference between Variable and Absorption Costing.
2. Enumerate the advantages of Variable Costing over Absorption
Costing.
3. Prepare income statements under Variable and Absorption Costing.
4. Reconcile the net income computed under Variable and Absorption
costing.
5. Understandand the difference in net operating income computed
under Variable versus Absorption Costing.
Guide Question:
1. Why reported income is crucial in the perforamnce of mnagers ?
2. Why inventory costing is important in reporting net income?
3. Why is absorption costing method prefered in reporting financial
statements than variable costing method?
4. How does Variable and Absorption Costing differ when income
statement is prepared?
MODULE
1. Meaning of variable and Absorption Costing.
2. Advantages of Variable over Absorptio Costing.
3. What method is preferred by users when preparing Financial
Statements.
Important Terms to Remember:
Absorption Costing
- Also called full, traditional, coventional and normal costing.
- All manufacturing costs, fixed and variable are treated as product
inventoriable costs
Variable Costing
- Only variable manufacturing costs are included as inventoriable
costs.
- All fixed manufacturing costs are excluded from inventoriable costs
and treated as period costs.
- Technically speaking, variable costing and direct costing are different.
- Variable costing includes variable production costs as part of the
product cost while direct costing includes all costs directly identified
with the segment as product costs.
- Variable costing focuses on the contribution margin while direct
costing zeroes-in on segment margin
- The unit costs from the preceding period are the same in the current
period; meaning, unit costs are assumed to be constant.
Treatment of Fixed Overhead and other expenses
- Under absorption costing, Fixed Overhead is aproduct cost,
inventoriable costs, or deferrable costs.
- This means that the costs assigned to the product is charged against
sales when the units are sold, and is still deferred in the inventory
when units are still unsold. This follows the principle of matching of
costs against revenue.
STRATEGIC COST MANAGEMENT

- Under variable costing, fixed overhead is a period cost, meaning, Problem Solving: 1)
outright an expense. This means the fixed overhead is immediately
charged against revenues without regard as to whether the units are During the year 200A, Wouie Corporation ‘s production was equal to its
already sold or still unsold. This follows the immediate recognition normal capacity of 1,000 units. It sold 900 units at a price of P50 per unit.
principle. The rationale for the treatment is because the fixed
overhead would be incurred regardless of whether the production The following costs were incurred during the year:
occurs or not, and therefore should not be treated as product cost. Total Cost
Direct materals P12,000
Product costs under Absorption Costing include: Direct labor 10,000
- Direct Materials, Labor, Variable Manufacturing Overhead and Fixed Variable factory overhead 8,000
Manufacturing Overhead. Fixed factory overhead 6,000
Variable selling and administrative 4,500
Period costs under Absorption Costing include: Fixed selling and administrative 3,000
- Variable and Fixed selling and administrative expenses
REQUIRED:
Product costs under Variable Costing include: a) Product cost per unit under Absorption and Variable Costing.
- Direct Materials, Labor, and Variable Manufacturing Overhead b) Net income under Absorption and Variable Costing

Period costs under Variable Costing include:

- Fixed Manufacturing Overhead, Variable and Fixed selling and Problem Solving: 2)
administrative expenses
Irish Corporation uses a standard costing system for aproduct that it
manufactures. For the year 200A, the following standards were established
Net Operating Income: Absorption Costing vs. Variable Costing based on normal production of 1,000 units:
- a) When P = S Net Income under AC = VC Total cost
- b) When P > S Net Income in AC is > VC Materials 2 pcs.@ P6 per piece P 12
- c) When P < S Net income in AC is < VC Labor 5 hrs. @ P4 per hour 20
Variable overhead 5 hrs. @ P3 per hour 15
Fixed factory overhead (5 hrs @P2) 10
Amount of Inventory of Absorption Costing vs. Variable Costing Total standard costs per unit P 57
- Inventory value reported under Absorption Costing is higher than
Variable costing because the inventory amount carries with it the Following are the actual data for the year 200A:
fixed overhead incurred during the period Production 1,100 units
Sales 950 units
Selling price P 80

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STRATEGIC COST MANAGEMENT

Materials (2,250 @ P5.80) 13,050 Sources/ References:

Labor (5,420 hrs @ P4.30 per hr.) 23,306 BOOK READING/S
Variable overhead 15,718  Strategic Cost Management by Elenita Cabrera
Fixed factory overhead 12,000  Management Advisory Services by Rodelio Roque
Selling and admin expenses:
Variable 5,700
Fixed 8,000

REQUIRED:
a) Variances for each cost element of production

b) Comparative Income Statement (Absorption vs. Variable Costing)

c) Reconciliation of the difference in net income of Variable and

Aborption Costing

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