COLLEGE OF ACCOUNTANCY

First Semester | AY 2021-2022

Variable and Absorption Costing

Before looking at absorption versus variable costing, it will be important to

understand the difference between direct and indirect costs on the income
statement. Direct costs are usually associated with COGS, which affects a company’s
gross profit and gross profit margin. Indirect costs are associated with the
operating expenses of a company and will heavily influence operating profit and
the operating profit margin.

 Absorption costing includes all of the direct costs associated with manufacturing a
product. This is also known as full costing, entails allocating fixed overhead costs
across all units produced for the period, resulting in a per-unit cost.

 Variable costing includes all of the variable direct costs in COGS but excludes
direct, fixed overhead costs.

Illustration

 Covid is a manufacturer of face shield sold for P100 each. The following are the cost,
production and sales for the month of May 2020.

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 COLLEGE OF ACCOUNTANCY
First Semester | AY 2021-2022

The income statement under Absorption and Variable Costing will be presented this way.

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First Semester | AY 2021-2022

Analysis:

 There is a difference in net income of P9,600.

The reason is the fixed factory overhead that was traceabele as product cost.

The item produced was 2,000 units higher than what it was able to sell. And the fixed
factory overhead per unit produce is P4.8/u. (P48,000/10,000)

2,000 x P4.8 FMOH/u = P9,600

Merit and Limitation of Variable Costing.

 This method highlights the relationship between sales and variable production
costs.
 May be easier for members of management who are not formally trained in
accounting.
 Variable costing is not a generally accepted method of inventory costing for
external purposes because total costs are not matched with sales revenue and does
not include fixed factory overhead in the work in process and finished goods
inventories.

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