Strategic Cost Management

Absorption and Variable Costing

Illustrative Example

Case.

Ifugao Industries produces and sells a single product.

Selected cost and operating data relating to the product for two years are given below:

Selling price per unit . . . . . . . . . . . . . . . . . . . . . . . . P50

Manufacturing costs:

Variable per unit produced:

Direct materials . . . . . . . . . . . . . . . . . . . . . . . . . P11
Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . P6
Variable manufacturing overhead . . . . . . . . . . . P3
Fixed manufacturing overhead per year . . . . . . . . P120,000

Selling and administrative expenses:

Variable per unit sold . . . . . . . . . . . . . . . . . . . . . . P4

Fixed per year. . . . . . . . . . . . . . . . . . . . . . . . . . . . P70,000

Year 1 Year 2
Units in beginning inventory . . . . . . . . . . . . . 0 2,000
Units produced during the year . . . . . . . . . . . 10,000 6,000
Units sold during the year . . . . . . . . . . . . . . . 8,000 8,000
Units in ending inventory . . . . . . . . . . . . . . . . 2,000 0

Required.

1. Assume the company uses absorption costing.

a. Compute the unit product cost in each year.
b. Create an income statement for each year.

2. Assume the company uses variable costing.

a. Compute the unit product cost in each year.
b. Create an income statement for each year.

3. Reconcile the variable costing and absorption costing net operating incomes.

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 Solutions:
1.
a. Absorption Costing – Unit Product Cost

Year 1 Year 2
Direct Materials P11 P11
Direct Labor 6 6
Variable Manufacturing Overhead 3 3
Fixed Manufacturing Overhead
(P120,000 / 10,000 units) 12
(P120,000 / 6,000 units) 20
Absorption Costing Unit Product Cost P32 P40

b. Absorption Costing – Income Statement

Ifugao Industries
Statement of Profit and Loss
For the Periods, Year 1 and Year 2

Year 1 Year 2
Sales (8,000 units x P50 per unit) P400,000 P400,000

Less: Cost of Goods Sold

Beginning Inventory 0 64,000
Produced Inventory (10,000 x 32) 320,000
( 6,000 x 40) 240,000
Ending Inventory ( 2,000 x 32) ( 64,000) 0
Total 256,000 304,000

Gross Margin 144,000 96,000

Less: Selling & Administrative Expenses

Variable Expenses 32,000 32,000

(8,000 x P4)
Fixed Expenses 70,000 70,000
Total 102,000 102,000

Net Operating Income P 42,000 P (6,000)

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 2.
a. Variable Costing – Unit Product Cost

Year 1 Year 2
Direct Materials P11 P11
Direct Labor 6 6
Variable Manufacturing Overhead 3 3

Variable Costing Unit Product Cost P20 P20

b. Variable Costing – Income Statement

Ifugao Industries
Statement of Profit and Loss
For the Periods, Year 1 and Year 2

Year 1 Year 2
Sales (8,000 units x P50 per unit) P400,000 P400,000

Less: Variable Costs & Expenses

Cost of Goods Sold ( 8,000 x 20) 160,000 160,000
Selling & Administration ( 8,000 x 4) 32,000 32,000
Total 192,000 192,000

Contribution Margin 208,000 208,000

Less: Fixed Costs & Expenses

Fixed Manufacturing Overhead 120,000 120,000

Fixed Selling & Administrative 70,000 70,000
Total 190,000 190,000

Net Operating Income P 18,000 P 18,000

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 3. Reconciliation

Year 1 Year 2
Variable Costing – Net Operating Income P18,000 P18,000

Add: Deferred Fixed Manufacturing Overhead

attributed to Ending Inventory Unsold 24,000

Less: Expensed Fixed Manufacturing Overhead

Attributed to Ending Inventory Released 24,000

Absorption Income – Net Operating Income P42,000 P (6,000)

Prepared by: John G. Pagaddut, CPA, LPT, MSA

Course Instructor

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