ReSA - THE REVIEW SCHOOL OF ACCOUNTANCY

CPA Review Batch 41  May 2021 CPA Licensure Examination  Week No. 3

MANAGEMENT ADVISORY SERVICES C.P. Lee  E.S Arañas  K.L. Manuel

MAS-04: ABSORPTION & VARIABLE COSTING WITH PRICING DECISION

ABSORPTION COSTING VARIABLE COSTING
1. Other Names Full Costing, GAAP Costing Direct Costing, Marginal Costing
2. Treatment of FFOH Product Cost: Inventory, then Expense Period Cost: Full Amount as Expense
3. Reason behind Treatment FFOH is necessary to produce units FFOH is incurred with or without production
4. Period Costs Selling & Administrative Expenses FFOH, Selling & Administrative Expenses
5. Product Costs DM, DL, VFOH & FFOH DM, DL & VFOH
6. Cost of Inventory Higher than Variable Costing’s Lower than Absorption Costing’s
7. Matching Principle Compliant Non-Compliant
8. Income Statement Functional Presentation (“CGS” Format) Behavioral Classification (“CM” Format)
9. Main Function External Financial Reporting Management Decision Aid (Internal Use)
10. Common Applications Financial Statements, Reporting to BIR & SEC CVP Analysis, Relevant Costing, Pricing Decision
Where: FFOH – Fixed Factory Overhead DM – Direct Materials CGS – Costs of Goods Sold
VFOH – Variable Factory Overhead DM – Direct Labor CM – Contribution Margin
 Under AC, FFOH costs are initially inventoried and expensed only when related units are sold.
 Under VC, FFOH costs are fully expensed in the period incurred (i.e. outright expense regardless of sales).
 AC Profit vs. VC Profit:
Situation Implication Explanation
Since Ending Inventory = Beginning Inventory, then
1 Production = Sales AC Profit = VC Profit
FFOH expensed under AC is equal to FFOH expensed under VC
Since Ending Inventory > Beginning Inventory, then
2 Production > Sales AC Profit > VC Profit
FFOH expensed under AC is lower than FFOH expensed under VC
Since Ending Inventory < Beginning Inventory, then
3 Production < Sales AC Profit < VC Profit
FFOH expensed under AC is higher than FFOH expensed under VC

∆ Profit = ∆ Inventory x unit FFOH

Where: ∆ Profit = AC Profit – VC Profit
∆ Inventory = Production – Sales = Ending Inventory – Beginning Inventory
Unit FFOH = Total FFOH ÷ Production
 Profit under VC fluctuates with sales (not production); production influences profit under AC (not under VC).
PRICING DECISION - is the process of determining the selling price of a product with main objective of
maximizing profit. In general, the price of a product is dependent upon its demand and supply.
[Law of supply and demand shall be discussed thoroughly in MAS-09 (Economics).]
 Major factors that influence pricing decisions (3C’s):
1. CUSTOMERS - Customers’ preference for a product and their willingness to pay for it is largely affected
by the product’s selling price.
2. COMPETITORS - The prices charged by competitors for substitute products affect the price that a
company can charge for its product.
3. COSTS - Lower production costs allow a company to charge a competitive price for its product.
The value that customers place on the product and the prices competitors charge for competing products
affect DEMAND, while the costs of producing and delivering the product influence SUPPLY.
 General pricing approaches:
1. VALUE-BASED – prices are based on buyer’s perception of product value instead of on seller’s costs.
2. COMPETITION-BASED – prices are mainly influenced by the price of competing products.
A) Going-rate pricing: price = competitor’s price
B) Bidding (sealed-bid pricing): price = lowest price among bidders
C) Target costing: In target costing, selling price is usually known before the product is developed.
 Step 1 – Market price is determined based on competition and customer demand.
 Step 2 – Target cost is computed based on formula: target cost = market price – desired profit.
 Step 3 – Life-cycle costs are reduced to reach the target cost level by doing value engineering.
[Value engineering & life-cycle costs shall be discussed thoroughly in MAS-10 (Strategic Cost Management).]
 Step 4 – Product is dropped if cost-cutting measures do not bring costs down to target levels.
3. COST-BASED – prices shall cover value chain costs and provide the desired return on investment.
A) Cost-plus pricing: price = certain costs + target profit
B) Mark-up pricing: price = full costs + target percentage on costs or selling price
4. Other pricing strategies:
A) Price Skimming – setting an introductory price relatively high to attract non-price-sensitive buyers
so that the firm may recover its research and development costs.
B) Penetration Pricing – setting an introductory price relatively low to gain deep market penetration.
C) Predatory Pricing – an illegal scheme where products are priced below cost to destroy competitors.
 Price adjustment strategies:
1. Cash Discounts – offered to encourage prompt payment of customer dues (e.g., 2/10, n/30).
2. Volume Discounts – offered to customers who purchase in large quantities.
3. Seasonal Discounts – offered to encourage sale and stabilize production of out-of-season products.
4. Functional Discounts – offered to member of trade channel for performing certain tasks, such as selling.
5. Allowances – price reductions that can take the form of a trade-in or promotional allowance.

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 ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY MAS-04
Week No. 3: ABSORPTION & VARIABLE COSTING with PRICING DECISION

EXERCISES: ABSORPTION and VARIABLE COSTING with PRICING DECISION

1. ABSORPTION COSTING vs. VARIABLE COSTING
Aki Company makes a single product that sells for P 1,000 each. Data for 2021’s operations follow:
Units: Variable Costs:
Beginning Inventory 5 Direct Materials P 18,000
Production 60 Direct Labor 12,000
Ending Inventory 15 Factory Overhead 6,000
Selling and Administrative 1,000
Fixed Costs:
Factory Overhead P 15,000
Selling and Administrative 2,000
REQUIRED:
1. Determine the inventory cost per unit under:
1A) Absorption costing 1B) Variable costing
2. Determine the total cost of ending inventory under:
2A) Absorption costing 2B) Variable costing
3. Prepare income statements under 3A) absorption costing and 3B) variable costing.
4. How much is the difference in profit between the two costing methods?
(Adapted: Managerial Accounting by Garrison)
SOLUTION GUIDE to requirement 3
AKI COMPANY
Income Statement, for the period of 2021
3A) ABSORPTION Costing 3B) VARIABLE Costing
Sales P Sales P
- Costs of Sales ____________ - Variable Costs ____________
Gross Profit P Contribution Margin P
- Expenses ____________ - Fixed Costs ____________
Net Income P Profit P
2. COST-PLUS PRICING
Adri Company has provided the following data for one of its products:
Direct materials P 8.00
Direct labor 7.00
Variable manufacturing overhead 2.00
Variable SG&A expenses 3.00
The company produces and sells 15,000 units of this product each year. Fixed manufacturing overhead
cost total P 15,000 per year and fixed SG&A expenses total P 30,000 per year.

2A) If
company uses the absorption approach to pricing and desires a 50% markup, then what is the
target
selling price per unit?
a. P 34.50 c. P 27.00
b. P 31.50 d. P 23.00
2B) If
company uses the contribution approach to pricing and desires a 35% markup, then what is the
target
selling price per unit?
a. P 29.70 c. P 22.95
b. P 27.00 d. P 20.00
(Adapted: Managerial Accounting by Garrison)
3. MARK-UP PRICING
AJ Company started operations on January 1, 2021 and expected to produce 200,000 units in its first
year of operations. The cost data per unit based on expected production are shown below:
Direct materials P 48.00
Direct labor P 12.00
Variable overhead P 6.00
Variable selling and admin. expense P 2.50
Fixed overhead P 3.00
Fixed selling and admin. expense P 2.00
AJ Company is trying to decide on what selling price that they will use to project the 2021 sales.
REQUIRED: Determine the unit selling price under each of the following cases.
1. 25% mark-up based on prime costs.
2. 70% mark-up based on conversion costs.
3. 22% mark-up based on variable production costs.
4. 24% mark-up based on variable costs
5. 20% mark-up based on full absorption costs.
6. 20% mark-up based on full costs.
7. Assuming AJ has excess capacity after 200,000 units and an offer to buy 20,000 units by a local
buyer is received, what is the minimum selling price on this offer if no selling and administrative
costs will be incurred, except for P 2 per unit for shipping?
(Adapted: Managerial Accounting by Edmonds)

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 ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY MAS-04
Week No. 3: ABSORPTION & VARIABLE COSTING with PRICING DECISION

WRAP-UP EXERCISES
1. The fundamental difference between variable and absorption costing is the expensing of:
a. Direct manufacturing costs c. Variable marketing costs
b. Fixed manufacturing costs d. Fixed marketing costs
2. Under absorption costing, fixed manufacturing overhead costs are best described as
a. Direct period costs c. Direct product costs
b. Indirect period costs d. Indirect product costs
3. Under variable costing,
a. All period costs are variable c. All period costs are fixed
b. All product costs are variable d. All product costs are fixed
4. As compared to absorption costing inventory cost, inventory cost under variable costing is typically
a. Lower c. The same
b. Higher d. The same but higher in certain cases
Items 5 to 7 are based on the following information
White Company manufactures a single product. Unit variable production costs are P 20 and fixed
production costs are P 150,000. White uses a normal activity of 10,000 units. White began the year
with no inventory, produced 12,000 units, and sold 7,500 units.
5. How much is the unit product cost under variable costing?
a. P 20.00 c. P 35.00
b. P 32.50 d. P 40.00
6. How much is the unit product cost under absorption costing?
a. P 20.00 c. P 35.00
b. P 32.50 d. P 40.00
7. What is the volume or capacity variance under absorption costing?
a. P 24,000 unfavorable c. P 30,000 unfavorable
b. P 24,000 favorable d. P 30,000 favorable
NOTE: volume variance = (actual production – normal production) x unit FFOH
8. Violet Company produced 10,000 units and sold 9,000 units. Fixed manufacturing overhead costs were
P 20,000, and variable manufacturing overhead costs were P 3 per unit. Which of the following best
describes the profit under the absorption costing method?
a. P 2,000 more than profit under variable costing method
b. P 5,000 more than profit under variable costing method
c. P 2,000 less than profit under variable costing method
d. P 5,000 less than profit under variable costing method
9. If ending inventory is higher than beginning inventory, then absorption costing profit is expected to be
a. Lower than variable costing profit c. Equal to the variable costing profit
b. Higher than variable costing profit d. Incomparable with variable costing profit
10. Green Company has an operating income of P 50,000 under direct costing. Beginning and ending
inventories were 13,000 units and 18,000 units, respectively. If the fixed factory overhead application
rate is P 2 per unit, then what is the operating income under the absorption costing?
a. P 70,000 c. P 50,000
b. P 60,000 d. P 40,000
11. Black Company had 16,000 units in its beginning inventory. The company’s variable production costs
were P 6 per unit and its fixed manufacturing overhead costs were P 4 per unit. The company’s net
income for the year was P 24,000 lower under absorption costing than it was under variable costing.
How many units does the company have in its ending inventory?
a. 22,000 units c. 6,000 units
b. 10,000 units d. 4,000 units
12. Pink Company had a net income of P 85,500 using variable costing and net income of P 90,000 using
absorption costing. Total fixed manufacturing overhead cost was P 150,000, and production was
100,000 units. How did the inventory level change during the year?
a. 3,000 units increase c. 4,500 units increase
b. 3,000 units decrease d. 4,500 units decrease
13. Under a just-in-time (JIT) production environment, profit under absorption costing tends to be
a. Higher than that of variable costing c. Equal to that of variable costing
b. Lower than that of variable costing d. Not equal to that of variable costing
14. Variable costing profit fluctuates with (A) and does not react to changes in (B).
a. (A) sales (B) production c. (A) sales (B) demand
b. (A) production (B) sales d. (A) production (B) supply
15. When using the absorption approach to cost-plus pricing,
a. All costs are included in the cost base.
b. The cost base is made up of the unit manufacturing costs.
c. The “plus” or markup figure contains fixed costs and desired profit.
d. Only selling and administrative expenses are included in the cost base.
16. When using the contribution approach to cost-plus pricing,
a. All costs are included in the cost base.
b. The cost base is made up of the variable costs associated with the product.
c. The “plus” or markup figure contains all manufacturing costs and desired profit.
d. The cost base is made up of the variable production costs plus all selling and
administrative costs associated with the product.

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 ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY MAS-04
Week No. 3: ABSORPTION & VARIABLE COSTING with PRICING DECISION

17. Product pricing is generally influenced by the following factors, except:

a. Competition c. Seller’s cost structure
b. Consumer demand d. Buyer’s profit objective
18. Which one of the following best represents the steps followed in target costing?
a. Use value engineering and kaizen costing to reduce costs, and determine desired price
b. Use kaizen costing to reduce costs, determine desired mark-up, and set the market price
c. Use value engineering to reduce costs, calculate target costs, and set the desired price
d. Determine market price, calculate target cost, and use value engineering to reduce costs
19. Which of these price adjustment strategies is designed to stabilize production for the selling firm?
a. Cash discounts c. Functional discounts
b. Quantity discounts d. Seasonal discounts
20. Variable costing is unacceptable for
a. Financial reporting c. Cost-volume-profit analysis
b. Transfer pricing d. Short-term decision making

SELF-TEST QUESTIONS - with suggested answers

(Sources: CMA/CIA/RPCPA/AICPA/Various test banks)
1. What is the costing method that treats all fixed costs as period costs?
C a. Absorption costing c. Variable costing
b. Job-order costing d. Process costing
2. Brown Co.’s 2021 fixed manufacturing overhead costs totaled P 100,000 and variable selling costs totaled P 80,000.
Under direct (variable) costing, how should these costs be classified?
Period Costs Product Costs
D a. P0 P 180,000
b. P 80,000 P 100,000
c. P 100,000 P 80,000
d. P 180,000 P0
3. A basic tenet of direct costing is that period costs should be currently expensed. What is the basic rationale behind
this procedure?
D a. Period costs are uncontrollable and should not be charged to a specific product
b. Period costs are generally immaterial in amount and the cost of assigning the amount to specific
products would outweigh the benefits
c. Allocation of period costs is arbitrary at best and could lead to erroneous decisions by management
d. Period costs will occur whether or not production occurs and so it is improper to allocate these costs to
production and defer a current cost of doing business
4. Under variable costing,
B a. Net income will tend to move based on changes in levels of production
b. Inventory costs will always be lower than under absorption costing
c. Net income will always be higher than under absorption costing
d. Net income will tend to vary inversely with production changes
5. The Rainbow Company had the following costs for 2021:
Raw materials P 700,000 Rent for factory building P 50,000
Direct labor 100,000 Rent for sales office 30,000
Miscellaneous FOH (fixed) 80,000 Depreciation on store equipment 20,000
Depreciation on machines 40,000
How much of these costs should be inventoried under absorption (A) and variable (V) costing methods?
C a. (A) 1,020,000 (V) 880,000 c. (A) 970,000 (V) 800,000
b. (A) 1,000,000 (V) 880,000 d. (A) 930,000 (V) 800,000
6. White Company manufactures a single product and has the following cost structure:
Variable costs per unit:
Direct materials P3
Direct labor 4
Variable manufacturing overhead 1
Variable selling and administrative expense 2
Fixed costs per month:
Fixed manufacturing overhead P 100,000
Fixed selling and administrative 60,000
The company produces 20,000 units each month. The unit product cost under absorption costing
C a. P 10 c. P 13
b. P 12 d. P 15
7. Refer to the data in No. 6, what is the unit product cost under variable costing?
A a. P 8 c. P 11
b. P 10 d. P 13
8. Refer to the data in No. 6, assuming there are no beginning inventories, 20,000 units are produced and 19,000 units
are sold in a month. If the unit selling price is P 20, what is the net income under absorption costing?
B a. P 30,000 c. P 38,000
b. P 35,000 d. P 42,000
9. Refer to the data in No. 6 assuming there are no beginning inventories and 20,000 units are produced and 19,000
units are sold in a month. If the unit selling price is P 20, what is the net income under variable costing?
A a. P 30,000 c. P 38,000
b. P 35,000 d. P 42,000

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 ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY MAS-04
Week No. 3: ABSORPTION & VARIABLE COSTING with PRICING DECISION

10. The use of variable costing requires knowing

D a. The controllable and non-controllable components of all costs
b. The number of units of each product produced during the period
c. The contribution margin and break-even point for all the units produced
d. The variable and fixed components of production costs
11. Black Company began its operations on January 1, 2021, and produces a single product that sells for P 10 per unit.
Black uses an actual (historical) cost system. In 2021, 100,000 units were produced and 80,000 units were sold.
There was no work-in-process inventory at December 31, 2021. Manufacturing costs and selling and administrative
expenses for 2021 were as follows:
Fixed costs Variable costs
Raw materials - P 2.00 per unit produced
Direct labor - P 1.25 per unit produced
Factory overhead P 120,000 P 0.75 per unit produced
Selling and administrative 70,000 P 1.00 per unit sold
What would be Brown’s operating income for 2021 under variable (direct) costing method?
B a. P 114,000 c. P 234,000
b. P 210,000 d. P 330,000
Items 11 and 12 are based on the following information
A company manufactures and sells a single product. Planned and actual production in its first year of operation was
100,000 units. Planned and actual costs for that year were as follows:
Manufacturing Non-manufacturing
Variable P 600,000 P 500,000
Fixed 400,000 300,000
The company sold 85,000 units of product at a selling price of P 30 per unit.
12. Using absorption costing, the company’s operating profit was
B a. P 750,000 c. P 975,000
b. P 900,000 d. P 1,020,000
13. Using variable costing, the company’s operating profit was
B a. P 750,000 c. P 915,000
b. P 840,000 d. P 975,000
14. Income under absorption costing may differ from income under variable costing. How is this difference calculated?
A a. Change in the quantity of units in inventory times the fixed factory overhead rate per unit
b. Number of units produced during the period times the fixed factory overhead rate per unit
c. Change in the quantity of units in inventory times the variable manufacturing cost per unit
d. Number of units produced during the period times the variable manufacturing cost per unit
15. Blonde, Inc. manufactured 7,000 units last year. The ending inventory consisted of 100 units. There was no
beginning inventory. Variable manufacturing costs were P 6.00 per unit and fixed manufacturing costs were P 2.00 per
unit. What would be the change in the peso amount of ending inventory if variable costing was used instead of
absorption costing?
D a. P 800 decrease c. P 0
b. P 200 increase d. P 200 decrease
16. When production exceeds sales, fixed manufacturing overhead costs
B a. Are released from inventory under absorption costing
b. Are deferred in inventory under absorption costing
c. Are released from inventory under variable costing
d. Are deferred in inventory under variable costing
17. During its first year of operations, a company produced 275,000 units and sold 250,000 units. The following costs
were incurred during the year:
Variable costs per unit
Direct materials P 15.00
Direct labor 10.00
Manufacturing overhead 12.50
Selling and administrative 2.50
Total fixed cost
Manufacturing overhead P 2,200,000
Selling and administrative P 1,375,000
The difference between absorption costing profit and variable costing profit is that absorption costing profit is:
A a. P 200,000 greater c. P 325,000 greater
b. P 220,000 greater d. P 62,500 less
18. What best accounts for profit difference between absorption costing and variable costing method?
D a. Difference in fixed costs incurred c. Difference in sales revenue
b. Difference in variable costs incurred d. Difference in inventory valuation
19. Lavender Company’s income under absorption costing was P 3,600 lower than its income under variable costing. The
company sold 10,000 units during the year, and its variable costs were P 9 per unit, P 1 of which represents the
variable selling expense. If production cost was P 11 per unit under absorption costing, then how many units did the
company produce during the year?
B a. 8,200 units c. 11,200 units
b. 8,800 units d. 11,800 units
20. Variable costing and absorption costing will show the same incomes when there are no
D a. Beginning inventories c. Variable costs
b. Ending inventories d. Beginning and ending inventories

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 ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY MAS-04
Week No. 3: ABSORPTION & VARIABLE COSTING with PRICING DECISION

21. Absorption costing and variable costing differ in that

C a. Standards can be used with absorption costing, but not with variable costing.
b. Absorption costing inventories are more correctly valued.
c. Production influences income under absorption costing, but not under variable costing.
d. Companies using absorption costing have lower fixed costs.
22. When sales are constant but production fluctuates,
D a. Net income will be erratic under variable costing
b. Absorption costing will always show a net loss
c. Variable costing will always show a positive net income
d. Net income will be erratic under absorption costing
23. Red Co. had the same activity in 2021 as in 2020, except that production was higher in 2021 (vs. 2020). Red will show
C a. Higher income in 2021 than in 2010
b. The same income in both years
c. The same income in both years under variable costing
d. The same income in both years under absorption costing
24. Violet Company manufactures a single product. Unit variable production costs are P 20 & fixed production costs are P
150,000. Violet uses a normal activity of 10,000 units to set its standard costs. Violet began the year with no
inventory, produced 11,000 units, & sold 10,500 units. What is the ending inventory under absorption costing?
C a. P 10,000 c. P 17,500
b. P 15,000 d. P 20,000
25. A company’s production facility has an ideal capacity of 12,500 units, which was used as the basis for the normal
capacity of 10,000 units. The company was able to produce 11,000 units during the period. Fixed manufacturing costs
were P 200,000 while variable manufacturing costs were also P 200,000. What was the volume or capacity variance
for the production?
B a. P 20,000 unfavorable c. P 24,000 favorable
b. P 20,000 favorable d. P 40,000 favorable
26. It is the expected market price for a product or service, considering the consumers’ perception of value and the
competitors’ responses.
B a. Transfer price c. Cost-based price
b. Target price d. Selling price
27. Based on the following information: volume of production – 10,000 units; capital employed – P 60,000; cost to produce
and sell – P 5.00 per unit. The unit selling price that will yield a 20% return on investment is:
B a. P 5.10 c. P 7.00
b. P 6.20 d. P 7.01
28. XYZ Company plans to introduce a new product. To compete effectively, the product could not be priced at more than
P30. The company requires a return on investment of 15% on all new products. The plan is to produce and sell
25,000 units a year. If the product requires a P 500,000 investment, then target cost should be:
A a. P 27.00 c. P 21.50
b. P 23.00 d. P 20.00
29. Based on sales of 500 units per year, a new product has estimated traceable costs of P 990,000. What is the target
price to obtain a 15% profit margin on sales?
A a. P 2,329 c. P 1,980
b. P 2,227 d. P 1,935
30. Fury Co. signed a government construction contract providing for a formula price of actual cost plus 10%. In addition,
Fury was to receive one-half of any savings resulting from the formula price being less than the target price of
P2,200,000. Fury’s actual costs incurred were P 1,920,000. How much should Fury receive from the contract?
C a. P 2,060,000 c. P 2,156,000
b. P 2,112,000 d. P 2,200,000
31. ABC Sporting Company is introducing a new product. It priced the new product low enough to generate excitement.
Which one of the following pricing approaches did management implement?
B a. Price skimming c. Cost-based pricing
b. Penetration pricing d. Market-based pricing
32. A manufacturing firm intentionally priced its product below cost to eliminate competition. It has a reasonable prospect
of recovering the resulting loss through higher prices once competition is eliminated or through a greater share in the
market. The manufacturing firm has engaged in
B a. Price discrimination c. Collusive pricing
b. Predatory pricing d. Black market pricing
33. Functional discounts are offered to
D a. Encourage large volume purchases {volume discount}
b. Encourage prompt payment, improve cash flows and avoid bad debts {cash discount}
c. Encourage sale and stabilize production of out-of-season products {seasonal discount}
d. Other members of the marketing channel for performing certain services, such as selling
34. Super variable costing treats which of the following costs as the only variable and product costs?
B a. Direct labor c. Straight-line depreciation of factory machine
b. Direct materials d. Supervisory salary of an assembly line manager
35. Super variable costing is sometimes referred to as
D a. Full costing c. Indirect costing
b. GAAP costing d. Throughput costing

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