PRODUCT COSTING

Lesson Objectives
 Explain the difference between absorption costing and
variable costing.
 Discuss the effect that changes in production level and
sales level have on net income measured under
absorption costing versus variable costing.
 Discuss the relative merits of absorption costing versus
variable costing for management decision making.
 Prepare the income statement under variable costing
and absorption costing.
 Reconcile net income under absorption costing to
variable costing.
 ABSORPTION COSTING VERSUS
VARIABLE COSTING

➢ Full or Absorption Costing

▪ Assigns all variable and fixed manufacturing costs to the
product
▪ Required for external reporting
➢ Variable Costing
▪ Assigns only variable manufacturing costs to the product
▪ Direct material, direct labor, variable manufacturing
overhead
ABSORPTION COSTING VERSUS VARIABLE COSTING
COMPARISON

Primary Difference
Under variable costing,
fixed manufacturing
overhead is an expense
in the current period.
 ABSORPTION COSTING VERSUS
VARIABLE COSTING
COMPARISON - Continued

➢ Variable costing does not defer fixed manufacturing

overhead to the future - i.e., they are not inventoried
➢ Net income under absorption costing compared to
net income under variable costing:
▪ Higher when units produced exceed units sold
▪ Lower when units produced are less than units sold
▪ Equal when units produced and sold are the same:
• There is no ending inventory so fixed costs are not
deferred into the future
 ABSORPTION COSTING VERSUS
VARIABLE COSTING

Example – Prem Company for 2019

➢ Manufactures Fix-it, a sealant for car windows
➢ Relevant data for the first month of production:
Data
Production 30,000
Sales 20,000
Normal Capacity 30,000

Selling Price 20
Variable Costs
Direct Materials 5
Direct Labor 3
Variable Factory Overhead 1
Variable sellling and admin. Expenses 2
Fixed Costs
Factory Overhead 120,000
Selling & Administrative Expenses 15,000
 Product Cost Computation
Absorption Variable
Costing Costing
Direct Materials 5.00 5.00
Direct Labor 3.00 3.00
Variable Factory Overhead 1.00 1.00
Fixed Factory Overhead (120,000/30,000) 4.00
Total Unit Cost 13.00 9.00
 Prem Company
Income Statement
For the Year Ended, Dec. 31, 2019
Absorption Costing
Sales 400,000
Less: Cost of Goods Sold
Beg. Inventory -
Add: COGM (30000 x P 13) 390,000
TGAS 390,000
Less: Inventory, End (10,000 x P 13) 130,000 260,000
Gross Profit 140,000
Less: Operating Expenses
Variable Selling & Admin Exp. (20000 x P 2) 40,000
Fixed Selling & Admin Expense 15,000 55,000
Net Income 85,000
 Prem Company
Income Statement
For the Year Ended, Dec. 31, 2019
Variable Costing
Sales 400,000
Less: Variable Cost of Goods Sold
Beg. Inventory -
Add: Var COGM (30000 x P 9) 270,000
TGAS 270,000
Less: Inventory, End (10,000 x P 9) 90,000 180,000
Manufacturing Margin 220,000
Less: Var. Selling & Admin Exp. (20000 x P 2) 40,000
Contribution Margin 180,000
Less: Fixed Costs
Fixed Factory Overhead 120,000
Fixed Selling & Admin Expense 15,000 135,000
Net Income 45,000
 Reconciliation
Net Income, Absorption Costing 85,000
Add: Fixed Overhead in Beginning Invty -
Total 85,000.00
Less: Fixed Overhead in Ending Invty (10000 x P4) 40,000.00
Net Income, Variable Costing 45,000.00
 Seatwork
• Prepare the income statement under
absorption costing and variable costing
assuming the following:
1. Same information as example
2. Production and sales data are as follows:
Production Sales
2020 30,000 30,000.00
2021 30,000 35,000.00