Absorption & Variable Costing

ABSORPTION COSTING – it is a costing method where it includes all manufacturing

costs (DM, DL, VFOH, FFOH) as part of the cost of the product. It treats fixed factory
overhead (FFOH) as a product cost. Absorption costing is also known as FULL
COSTING.
VARIABLE COSTING – it is a costing method where it only includes DM, DL and VFOH
as part of the cost of the product. It treats fixed factory overhead (FFOH) as a period
cost. Variable costing is also known as DIRECT COSTING.
PRODUCT COST – is part of the cost of the inventory that is being allocated to the
sold and unsold units. Current income is reduced only by the amount allocated to the
SOLD units.
PERIOD COST – is a cost that is fully charged to the expense accounts whether or
not the product taken into consideration is fully sold.

What are the components of Absorption & Variable Costing?

 Formula for Absorption Costing (Function of Expense Formula) & Variable Costing
(Flexible Budget Formula):

Other formula to consider:

Kaya fixed lang, kasi fixed lang yung nagkakaiba sa Absorption and Variable, parang reconciliation na to
RECONCILIATION OF INCOME UNDER ABSOPRTION AND VARIABLE COSTING:
Instance 1: When production equals sales, there is no change in inventory. Fixed FOH
that was expensed in the absorption costing was also expensed under variable
costing. Therefore:
IF
PRODUCTION = SALES
THEN
ABSORPTION COSTING INCOME = VARIABLE COSTING INCOME
Instance 2: When production is greater than sales, there is an increase in inventory.
Fixed FOH expensed under absorption costing is less than Fixed FOH expensed
under variable costing Therefore:
IF
PRODUCTION > SALES
THEN
ABSORPTION COSTING INCOME > VARIABLE COSTING INCOME
Instance 3: When production is less than sales, there is a decrease in inventory.
Fixed FOH expensed under absorption costing is greater than Fixed FOH expensed
under variable costing. Therefore:
IF
PRODUCTION < SALES
THEN
ABSORPTION COSTING INCOME < VARIABLE COSTING INCOME

SHORTCUT (Remember: Just follow the SIGN):

Production [SIGN] Sales
Absorption costing income [SIGN] Variable costing income
Ending inventory [SIGN] Beginning Inventory
Note: The difference between the EI and BI is due to Fixed Manuf. OH
Advantage and Disadvantage of Variable Costing
Advantage:
1. Simple and more understandable
2. Allocation of fixed cost is eliminated
3. Data for breakeven and CVP are already available
4. More compatible in Standard Cost Accounting System.
Disadvantage:
1. Violation of GAAP and matching principle
2. Segregation of variable and fixed cost might be difficult
3. Working Capital, Current Ratio and Acid-test ratio are UNDERSTATED.

Other things to consider:

1. Absorption costing is accepted under GAAP. It is used for external reporting.
- Fixed Manuf. OH = indirect product costs
2. Variable costing is not acceptable under GAAP. It is used for internal
reporting.
- Fixed Manuf. OH = indirect period costs
NOTE: The peso amount of inventories under VARIABLE COSTING is ALWAYS
LOWER than ABSORPTION COSTING.
- There is NO VOLUME OR CAPACITY VARIANCE under VARIABLE COSTING.
3. SELLING EXPENSE (whether fixed or variable should NOT be included)
4. Throughput costing – Under this costing method, only direct materials are
recorded as inventory costs while all other manufacturing costs (including DL
and VFOH) are expenses as period costs. Selling expense and General and
Administrative costs are also treated as period costs. It is usually used for
short-term capacity decisions.
- Throughput costing penalizes high production and rewards low production
Absorption & Variable
Costing
Advance Tutorials
Management Advisory Services
July 2020
What is Absorption and Variable Costing?
ABSORPTION COSTING – it is a costing method where it includes all
manufacturing costs (DM, DL, VFOH, FFOH) as part of the cost of the
product. It treats fixed factory overhead (FFOH) as a product cost.
Absorption costing is also known as FULL COSTING.

VARIABLE COSTING – it is a costing method where it only includes DM,

DL and VFOH as part of the cost of the product. It treats fixed factory
overhead (FFOH) as a period cost. Variable costing is also known as
DIRECT COSTING.
*QUICK REVIEW FOR PRODUCT AND PERIOD
COST*
PRODUCT COST – is part of the cost of the inventory that is being
allocated to the sold and unsold units. Current income is reduced only
by the amount allocated to the SOLD units.

PERIOD COST – is a cost that is fully charged to the expense accounts

whether or not the product taken into consideration is fully sold.
What are the components of Absorption &
Variable Costing?
Formulas for Absorption & Variable Costing
Formula Shortcuts for Absorption & Variable
Costing
[ANG LAGING HINIHINTAY]
Advantage and Disadvantage of Variable
Costing
Advantage:
1. Simple and more understandable
2. Allocation of fixed cost is eliminated
3. Data for breakeven and CVP are already available
4. More compatible in Standard Cost Accounting System.
Disadvantage:
1. Violation of GAAP and matching principle
2. Segregation of variable and fixed cost might be difficult
3. Working Capital, Current Ratio and Acid-test ratio are UNDERSTATED.
 OTHER THINGS TO CONSIDER
1. Absorption costing is accepted under GAAP. It is used for external reporting.
- Fixed Manuf. OH = indirect product costs

2. Variable costing is not acceptable under GAAP. It is used for internal reporting.
- Fixed Manuf. OH = indirect period costs
NOTE: The peso amount of inventories under VARIABLE COSTING is ALWAYS
LOWER than ABSORPTION COSTING.
- There is NO VOLUME OR CAPACITY VARIANCE under VARIABLE COSTING.
3. SELLING EXPENSE (whether fixed or variable should NOT be included)
OTHER THINGS TO CONSIDER:
4. Throughput costing – Under this costing method, only direct
materials are recorded as inventory costs while all other manufacturing
costs (including DL and VFOH) are expenses as period costs. Selling
expense and General and Administrative costs are also treated as
period costs.
- Used for short-term capacity decisions
THEORIES
Theories No. 1
Which of the following is correct?
a. If production is greater than sales then the absorption costing
income is lesser than the variable costing income.
b. If production is less than sales then the absorption costing income
is greater than the variable costing income.
c. If production is equal to sales then the absorption costing income is
equal to the variable costing income.
d. All of the above are false.
Theories No. 2
Which of the following cost is treated differently under absorption
costing and variable costing?
a. Direct Labor
b. Raw Materials
c. Fixed Manufacturing Overhead
d. Variable Manufacturing Overhead
Theories No. 3
Variable costing is unaccepted for:
a. Financial reporting
b. Transfer Pricing
c. CVP Analysis
d. Short-term decision making
Theories No. 4
What costs are treated as product costs under variable costing?
a. All variable costs
b. All direct costs only
c. All manufacturing costs
d. Only variable production costs
Theories No. 5
Which of the following cost items is not correctly accounted for as a
product cost under absorption costing and variable costing?
PRODUCT COST UNDER
ABSORPTION VARIABLE
a. Direct Materials YES YES
b. Factory oil YES YES
c. Straight-line depreciation YES YES
d. Salary of Corp. Supervisor NO NO
SAMPLE PROBLEM
SAMPLE PROBLEM 1
SAMPLE PROBLEM 2
SAMPLE PROBLEM 3
SAMPLE PROBLEM 4
SAMPLE PROBLEM 5
MAS Absorption and Variable Costing Problems
1. Taxation Corp. sells a single product for P25. It had no beginning inventories.
Operating data were as follows:

Sales (55,000 units) P1,375,000

Normal Capacity 60,000 units
Production Costs:
Variable per unit P13
Fixed production P300,000
Selling and Admin. Expense:
Variable per unit sold P2
Fixed selling P40,000
Number of units produced 66,000 units

Assume the actual costs were as budgeted.

Required:
1. How much is the amount of the company’s manufacturing margin? 660,000
2. Compute the net income under variable costing. 210,000
3. Compute the net income under absorption costing. 265,000
2. Tim Hortons Corporation has fixed manufacturing cost of P12 per unit.
Consider the three independent cases:
a. Absorption and variable costing net income each totaled P240,000 in a
period when the firm produced 18,000 units.
b. Absorption costing net income total P320,000 in a period when finished
goods inventory levels rose by 7,000 units.
c. Absorption costing net income and variable costing net income
respectively total P220,000 and P250,000 in a period when the beginning
finished goods inventory was 14,000 units.
Required:
1. In Case A, how many units were sold during the period? 18,000
2. In Case B, how much income would Tim Hortons Corporation report under
variable costing? 236,000
3. In Case C, how many units were in the ending finished goods inventory?
11,500
3. The RFBT Corporation, which uses, throughput costing, began operation at the
start of the current. Planned and actual production equaled 20,000 units, and
sales totaled 17,500 units at P95 per unit. The following data were given:
DM per unit P18
Conversion cost:
Direct Labor 160,000
Variable Manuf. OH 280,000
Fixed Manuf. OH 340,000
Selling and Admin. Cost 430,000
Required:
1. Compute the company’s total cost for the year. 1,570,000
2. How much of this cost would be held in year-end inventory under
throughput costing? 45,000 (2500 x 18)
3. How much will be the company’s net income under throughput costing?
137,500
4. AFAR Inc. sells a single product for P25. It had no beginning inventories.
Operating data were as follows:

Sales (27,000 units) P675,000

Normal Capacity 30,000 units
Productions Costs:
Variable per unit P13
Fixed production P150,000
Selling and Admin. Expense:
Variable per unit sold P2
Fixed selling P20,000
Number of units produced 32,500 units

Audit Note: Assume actual costs were as budgeted.

Required:
1. Compute the ending inventory under variable costing. 71,500
2. Compute income under variable costing. 100,000
3. For the following questions, assume absorption costing using normal
capacity as basis for computing the standard fixed cost per unit.
a. Compute ending inventory = 99,000
b. Net income = 127,500
 5. FAR Company has been producing facemask with the following manufacturing
and operating budget
DM per facemask P50
DL per facemask P10
Indirect material per facemask P20
Total fixed manuf. OH per year P100,000
Total fixed admin. exp per year P300,000
Total marketing exp for the year P200,000
Audit Note:
The company sells facemask through a commission agent company which charges
10% on sales. The variable freight out per unit of facemask which is shouldered by
the FAR Company is P40 per unit. The company normally produces 10,000 units per
year. During 2020, FAR Co. sold 8,000 units of facemask. The selling price of
facemask per unit is P200. During 2021, FAR Co. sold 11,000 units of facemask.
Required:
1. Cost per unit for variable costing P80
2. Cost per unit for absorption costing P90
3. Cost per unit for throughput costing P50
4. Variable costing net income/(loss) in 2020 (120,000)
5. Absorption costing net income/(loss) in 2020 (100,000)
6. Throughput costing net income/(loss) in 2020 (120,000)
7. Difference between absorption and variable costing net income in 2020
(20,000)
8. Variable costing net income/(loss) in 2021 60,000
9. Absorption costing net income/(loss) in 2021 50,000
10. Difference between absorption and variable costing net income in 2021
10,000
MAS Absorption & Variable Costing Theories
1. Which of the following must be known about a production process to institute
a variable costing system?
a. The direct and indirect costs related to production
b. Standard quantities and prices for all production inputs
c. The variable and fixed components of manufacturing costs
d. The capacity level or denominator level to be used on allocating fixed
overhead costs

2. Which of the following cost items is not correctly accounted for as a product
cost under absorption and variable costing?
PRODUCT COST UNDER
ABSORPTION VARIABLE
a. Direct Materials YES YES
b. Factory oil YES YES
c. Straight-line depreciation YES YES
d. Salary of Corp. Supervisor NO NO

3. Absorption costing and variable costing differ in that

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 no under
variable costing
d. The variable and fixed components of all costs related to production

4. Which of the following costs is treated differently under absorption and

variable costing?
a. Direct Labor
b. Raw materials
c. Fixed manufacturing overhead
d. Variable manufacturing overhead

5. Which of the following statements is most TRUE for a firm that uses variable
costing?
a. The cost of the unit of product changes because of change in number of
units manufactured
b. Profit fluctuates with sales
c. An idle facility variation in calculated
d. Product costs include variable administrative costs
6. If firm uses variable costing,
a. its product costs include variable selling and administrative costs
b. Its profits fluctuate with sales
c. It calculates an idle facility variation.
d. Its product cost per unit changes because of changes in number of units
produced

7. Under absorption costing, fixed manufacturing overhead costs are best

described as
a. Direct period costs
b. Indirect period costs
c. Direct product costs
d. Indirect product costs

8. Super variable costing is sometimes referred to as

a. Full costing
b. GAAP costing
c. Indirect costing
d. Throughput costing

9. Under variable costing, fixed manufacturing overhead costs are best

described as
a. Direct period costs
b. Indirect period costs
c. Direct product costs
d. Indirect product costs

10. True or False: Under variable costing, all product costs are variable.
11. True or False: Under variable costing, all variable costs are treated as
product costs.
12. True or False: In a normal production process where fixed factory overhead
costs are incurred, the cost of inventory under absorption costing is higher
than the cost of inventory under variable costing.
13. True or False: There is no volume or capacity variance under variable
costing.
14. True or False: Under Just-In-Time production environment, income under
absorption costing tends to be equal with income under variable costing.
15. True or False: Variable costing income fluctuates with production and does
not react to changes in sales.
 16. What costs are treated as product cost under variable costing?
a. All variable costs
b. All direct costs only
c. All manufacturing costs
d. Only variable production costs

17. If production is higher than sales, then absorption costing income is

expected to be
a. Lower than variable costing income
b. Higher than variable costing income
c. Equal to variable costing income
d. Incomparable with variable costing income

18. Variable costing is unacceptable for:

a. Financial reporting
b. Transfer pricing
c. CVP analysis
d. Short-term decision making
Note: Because financial reporting should report all costs incurred and is regulated
by standards.
19. Which of the following is correct?
a. If production is greater than sales, then the absorption costing income is
lesser than the variable costing income.
b. If production is less than sales, then the absorption costing income is
greater than the variable costing income.
c. If production is equal to sales, then the absorption costing income is equal
to the variable costing income.
d. All of the above are false.
ANSWER:
1. C
2. C
3. C
4. C
5. B
6. B
7. D
8. D
9. B
10. TRUE
11. FALSE
12. TRUE
13. TRUE
14. TRUE
15. FALSE
16. D
17. B
18. A
19. C