Absorption and

Variable Costing

Professor: John Anthony M. Labay, CPA, MBA

 Global Reciprocal Colleges
454 GRC Bldg. Rizal Ext. cor. 9th Avenue Grace Park, Caloocan City

TITLE: Absorption and Variable Costing

I. Learning Outcomes
1. Definition and Concept of Absorption Costing
2. Definition and Concept of Variable Costing
3. Difference between Absorption and Variable Costing

II. Discussion

Absorption costing is a costing system which treats all costs of production as product costs,
regardless weather they are variable or fixed. The cost of a unit of product under absorption
costing method consists of direct materials, direct labor and both variable and fixed overhead.
Absorption costing allocates a portion of fixed manufacturing overhead cost to each unit of
product, along with the variable manufacturing cost. Because absorption costing includes all costs
of production as product costs, it is frequently referred to as full costing method.

Variable costing is a costing system under which those costs of production that vary with output
are treated as product costs. This would usually include direct materials, direct labor and variable
portion of manufacturing overhead. Fixed manufacturing cost is not treated as a product costs
under variable costing. Rather, fixed manufacturing cost is treated as a period cost and, like selling
and administrative expenses, it is charged off in its entirety against revenue each period.
Consequently, the cost of a unit of product in inventory or cost of goods sold under this method
does not contain any fixed overhead cost. Variable costing is some time referred to as direct
costing or marginal costing.

To complete this summary comparison of absorption and variable costing, we need to briefly
consider the handling of selling and administrative expenses. These expenses are never treated
as product costs, regardless of the costing method in use. Thus, under either absorption or
variable costing, both variable and fixed selling and administrative expenses are always treated
as period costs and deducted from revenues as incurred.

Absorption Costing Variable Costing

Direct Materials
Direct Labor Product Cost
Product Cost
Variable Overhead
Fixed Overhead
Administrative Expenses Period Cost
Period Cost
Selling Expenses

Absorption costing is the costing method used for financial accounting and tax purposes because
it reflects a more comprehensive net income on income statement and a more complete cost of
inventories on balance sheet by shifting costs between different periods in accordance with the
matching concept.

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 Global Reciprocal Colleges
454 GRC Bldg. Rizal Ext. cor. 9th Avenue Grace Park, Caloocan City

Income Statement under Absorption Costing (Traditional Format):

Sales xx
Cost of Goods Sold (xx)
Gross Profit xx
Operating Expenses (xx)
Net Operating Income xx

Income Statement under Variable Costing (Contribution Format):

Sales xx
Variable Cost (xx)
Contribution Margin xx
Fixed Cost (xx)
Net Operating Income xx

Reconciliation of Variable Costing and Absorption Costing Net Operating Incomes:

Variable Costing Net Operating Income xx
Fixed Manufacturing Overhead Costs
Deferred / (Released) from Inventory
under Absorption Costing xx / (xx)
Absorption Costing Net Operating Income xx

Note:
If the production equals sales, AC NOI is equal to VC NOI.
If the production is greater than sales, AC NOI is greater than VC NOI.
If the production is less than sales, AC NOI is less than VC NOI.

III. Learning Exercises

1. The Company, which has only one product, has provided the following data concerning its most
recent month of operations:
Selling Price P 99

Units in beginning inventory 500

Units produced 6,800
Units sold 6,900
Units in ending inventory 400

Variable costs per unit:

Direct materials P 41
Direct labor P 28
Variable manufacturing overhead P3
Variable selling and administrative P8
Fixed costs:
Fixed manufacturing overhead P 47,600
Fixed selling and administrative P 82,800

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 Global Reciprocal Colleges
454 GRC Bldg. Rizal Ext. cor. 9th Avenue Grace Park, Caloocan City

The company produces the same number of units every month, although the sales in units vary
from month to month. The company's variable costs per unit and total fixed costs have been
constant from month to month.

Required:
a. What is the unit product cost for the month under variable costing?

b. What is the unit product cost for the month under absorption costing?

c. Prepare a contribution format income statement for the month using variable costing.

d. Prepare an income statement for the month using absorption costing.

e. Reconcile the variable costing and absorption costing net operating incomes for the month.

2. The Company, which has only one product, has provided the following data concerning its most
recent month of operations:
Selling Price P 104

Units in beginning inventory 0

Units produced 3,300
Units sold 3,000
Units in ending inventory 300

Variable costs per unit:

Direct materials P 26
Direct labor P 37
Variable manufacturing overhead P5
Variable selling and administrative P 10
Fixed costs:
Fixed manufacturing overhead P 16,500
Fixed selling and administrative P 45,000

Required:
a. What is the unit product cost for the month under variable costing?

b. What is the unit product cost for the month under absorption costing?

c. Prepare a contribution format income statement for the month using variable costing.

d. Prepare an income statement for the month using absorption costing.

e. Reconcile the variable costing and absorption costing net operating incomes for the month

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 Global Reciprocal Colleges
454 GRC Bldg. Rizal Ext. cor. 9th Avenue Grace Park, Caloocan City

3. The Company, which produces a single product, has provided the following data for its most
recent month of operation:
Number of units produced 5,000
Variable costs per unit:
Direct materials P 85
Direct labor P 67
Variable manufacturing overhead P2
Variable selling and administrative P1
Fixed costs:
Fixed manufacturing overhead P 70,000
Fixed selling and administrative P 185,000

The company had no beginning or ending inventories.

Required:
a. Compute the unit product cost under absorption costing.

b. Compute the unit product cost under variable costing.

4. The Corporation manufactures a variety of products. The following data pertain to the
company's operations over the last two years:
Variable costing net operating income, last year P 84,400
Variable costing net operating income, this year P 87,900
Increase in ending inventory, last year 1,300
Increase in ending inventory, this year 0
Fixed manufacturing overhead cost per unit P2

Required:
a. Determine the absorption costing net operating income for last year.

b. Determine the absorption costing net operating income for this year.

IV. Assessment

1. The Company, which has only one product, has provided the following data concerning its most
recent month of operations:
Selling Price P 117

Units in beginning inventory 0

Units produced 3,300
Units sold 3,200
Units in ending inventory 100

Variable costs per unit:

Direct materials P 31
Direct labor P 37
Variable manufacturing overhead P2
Variable selling and administrative P7

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 Global Reciprocal Colleges
454 GRC Bldg. Rizal Ext. cor. 9th Avenue Grace Park, Caloocan City

Fixed costs:
Fixed manufacturing overhead P 112,200
Fixed selling and administrative P 6,400

Required:
a. What is the unit product cost for the month under variable costing?

b. Prepare a contribution format income statement for the month using variable costing.

c. Without preparing an income statement, determine the absorption costing net operating income
for the month. (Hint: Use the reconciliation method.)

2. The Company, which has only one product, has provided the following data concerning its most
recent month of operations:
Selling Price P 123

Units in beginning inventory 300

Units produced 7,600
Units sold 7,400
Units in ending inventory 500

Variable costs per unit:

Direct materials P 46
Direct labor P 26
Variable manufacturing overhead P1
Variable selling and administrative P4
Fixed costs:
Fixed manufacturing overhead P 235,600
Fixed selling and administrative P 88,800

The company produces the same number of units every month, although the sales in units vary
from month to month. The company's variable costs per unit and total fixed costs have been
constant from month to month.

Required:
a. Prepare a contribution format income statement for the month using variable costing.

b. Prepare an income statement for the month using absorption costing.

3. The Company, which has only one product, has provided the following data concerning its most
recent month of operations:
Selling Price P 124

Units in beginning inventory 0

Units produced 6,100
Units sold 5,600
Units in ending inventory 500

Variable costs per unit:

Direct materials P 23
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 Global Reciprocal Colleges
454 GRC Bldg. Rizal Ext. cor. 9th Avenue Grace Park, Caloocan City

Direct labor P 43
Variable manufacturing overhead P2
Variable selling and administrative P 11
Fixed costs:
Fixed manufacturing overhead P 183,000
Fixed selling and administrative P 61,600

Required:
a. Prepare a contribution format income statement for the month using variable costing.

b. Prepare an income statement for the month using absorption costing.

4. The Corporation manufactures a variety of products. Last year, the company's variable costing
net operating income was P63,900 and ending inventory increased by 900 units. Fixed
manufacturing overhead cost per unit was P3.

Required:
Determine the absorption costing net operating income for last year.