Variable Costing Part 1

Issues in Variable Costing

- Presentation of Income Statement

- Treatment of the Fixed factory overhead
- Reconciliation of the difference in the net income
- Volume variance

Presentation of Income Statement

Absorption Costing – Full Costing – General Purpose Financial Statement

- DL, DM, Var OH, Fixed OH constitutes the Cost of Sales

- According to function (Either Manufacturing or Selling / Admin)

Variable Costing – Direct Costing Method – Internal Reporting Financial Statement

- According to behavior
- Deduct Variable costs first before Deducting Fixed Costs

The net income / loss in Absorption Costing may be the same or not the same with Variable costing.

It will depend on the treatment of the fixed factory overhead.

Treatment of the Fixed Overhead

Absorption Variable
DM Product Product
DL Product Product
Var OH Product Product
Fix OH Product Period
Var SA Period Period
Fix SA Period Period

Fixed Overhead in Absorption Costing is greater than the Fixed Overhead in Variable Costing
Net income in Absorption Costing is higher than the Net income in Variable Costing when the Units
Produced is higher than the Units Sold

Explanation:

Because of the difference between the treatment of the FOH in Absorption and Variable Costing

Expense in Absorption Costing is lesser than the Expense in Variable Costing

Explanation:

If the Units Sold is higher than the Units Produced the Net Income under Absorption Costing will be less
than the Net income under Variable Costing

Different types / kinds of Capacities

Theoretical/Ideal – Ideal number of product / amounts of product

Practical - highest realistic amount of output that a factory can maintain over the long term

Normal Capacity – amount of production volume that can be reasonably expected over the long term

Expected Capacity – more recent / updated version of normal capacity

POHR – Budgeted Overhead Cost / Budgeted Activity

If Expected Capacity is not given use Normal Capacity

If Normal Capacity is not given use Practical Capacity

If Practical Capacity is not given use Theoretical / Ideal Capacity

Volume Variance / Denominator Variance / Uncontrollable Variance

Only affects the Net Income of Absorption Costing

Doesn’t affect Variable Costing because FOH is not included in Variable Costing

Actual Activity – Normal Activity * Manufacturing Overhead Per Unit

Higher Actual Activity = Favorable / Deduct to Cost of Sales

Lower Actual Activity = Unfavorable / Add to Cost of Sales