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MS 3405 – Variable and Absorption Costing
LECTURE NOTES
1. Variable costing treats only those costs of
production that vary with output as product costs.
Ordinarily, direct materials, direct labor and
variable manufacturing overhead costs would be
included in product costs under variable costing.
Fixed manufacturing overhead is treated as a
period cost and is immediately charged off against
revenue each period.
2. Absorption costing treats all costs of production as
product costs, regardless of whether they are
variable or fixed in nature. Under the absorption
costing method, a portion of fixed manufacturing
overhead is allocated to each unit of product.
Comparison of Absorption and Variable Costing.
When comparing absorption costing and variable
costing income statements, the following points should
be noted:
1. Deferral of fixed manufacturing costs under
absorption costing. Under the absorption
costing method, if inventories increase then a
portion of the fixed manufacturing overhead costs
of the current period is deferred to future periods
through the inventory account. When the units are
later taken out of inventory and sold, the deferred
fixed costs flow through to the income statement.
2. Differences in inventories under the two
methods. The ending inventory figures under the
variable costing and absorption costing methods
are different. Under variable costing, only the
variable manufacturing costs are included in
inventory. Under absorption costing, both variable
and fixed manufacturing costs are included in
inventory.
Suitability for CVP analysis. The absorption costing
income statement is not well suited for providing data
for CVP computations since it makes no distinction
between fixed and variable costs. In contrast, the
variable costing method classifies costs by behavior
and is very useful in setting-up CVP computations.
Extended Comparison of Income Data.
1. Production equals sales (no change in inventories).
When production equals sales, there is no change
in inventories. If there is no change in inventories,
then there is no change in the fixed manufacturing
overhead costs in inventories under absorption
costing.
2. Production exceeds sales (inventories increase).
When production exceeds sales, inventories grow.
If inventories grow, then some of the current fixed
manufacturing overhead costs will be deferred in
inventories under absorption costing. Since all of
the current fixed manufacturing overhead costs
are expensed under variable costing, the net
income reported under absorption costing will be
greater than the net income reported under
variable costing.
3. Sales exceeds production (inventories decrease).
When sales exceeds production, inventories shrink.
If inventories decrease, then some of the fixed
manufacturing overhead costs that had been
deferred in inventories in previous periods will be
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TRINIDAD
MAY 2023
released to the income statement as a charge
against income as well as all of the current fixed
manufacturing overhead costs. Since only the
current fixed manufacturing overhead costs are
expensed under variable costing, the net income
reported under absorption costing will be less than
the net income reported under variable costing.
4. Long-term differences in income. Over an
extended period of time, the cumulative net
income figures reported under absorption costing
and variable costing will be about the same; they
will differ only by the amount of fixed
manufacturing overhead cost in ending inventories
under absorption costing. Cumulative net income
figures will be identical whenever ending
inventories are reduced to zero.
5. Changes in production volume. Variable costing
net income is not affected by changes in
production volume. Absorption costing net income
is affected by changes in production volume. For a
particular level of sales, net income under
absorption costing will increase as the level of
output increases and hence inventories increase.
Advantages of the Contribution Approach. There
are several advantages in using variable costing (and
the contribution approach) in internal reports and
analysis.
1. More useful for CVP analysis. Variable costing
statements provide data that are immediately
useful for CVP analysis since they categorize costs
based on their behavior.
2. Income is not affected by changes in production
volume. Under absorption costing, reported net
income is affected by changes in production since
fixed costs are spread across more or fewer units.
This can distort income and may even result in
income moving in an opposite direction from sales.
This does not occur under variable costing.
3. Avoids misunderstandings concerning unit product
costs. Absorption costing unit product costs can be
easily misinterpreted as variable costs since they
are stated on a per unit basis. Such a
misperception can lead to serious errors in making
decisions. Variable costing avoids this problem
since unit costs include only variable costs.
4. Fixed costs are more visible. The impact of fixed
costs on profits is emphasized because the total
amount of such costs for the period appears
separately and is highlighted in the income
statement rather than being buried in cost of
goods sold and ending inventory.
5. Understandability. Managers may find it easier to
understand variable costing reports because data
are organized by behavior and because variable
costing is much closer to a cash flow concept.
6. Control is facilitated. Variable costing ties in with
cost control methods such as flexible budgets.
7. Incremental analysis is more straight-forward.
Variable cost corresponds closely with the current
out-of-pocket expenditure necessary to produce
and sell products and services and can therefore
be used more readily in incremental analysis than
absorption costing data. And since variable costing
MS.3405
EXCEL PROFESSIONAL SERVICES, INC.

net income is closer to net cash flow than PROBLEM NO. 4.

absorption costing net income, it is likely to be Golden Gate Company makes network connectors that
more useful to companies that have cash flow sell for P500. Standard variable manufacturing cost is
problems. P200, and the standard fixed manufacturing cost is
STRAIGHT PROBLEMS P100, based on budgeted fixed cost of P10 millions
and budgeted production of 100,000 units. During
PROBLEM NO. 1. 2020, the company produced 96,000 units sold
Baker Company produced 30,000 units and sold 90,000. Actual fixed manufacturing costs were
28,000 units. Beginning inventory was zero. During P9,870,000; actual variable manufacturing costs were
the period, the following costs were incurred: P19,300,000. Selling and administrative expenses
Indirect labor P60,000 were P11,350,000, all fixed. There were no beginning
Indirect materials 30,000 inventories.
Other variable overhead 90,000
Fixed manufacturing 180,000 Requirements:
overhead 1. Prepare in income statement for Golden Gate
Fixed administrative 150,000 using standard variable costing.
expenses 2. Prepare a standard absorption costing income
Fixed selling expenses 120,000 statement.
Variable selling expenses, per unit 40
Direct labor, per unit 80 PROBLEM NO. 5.
Direct materials, per unit 20 Shark Company began operations on January 1 to
produce a fishing rods. It used a standard absorption
Requirements: costing system with a planned production volume of
Compute the peso amount of ending inventory using: 100,000 units. During its first year of operations, no
1. Absorption costing variances were incurred and there were no fixed
2. Variable costing selling or administrative expenses. Inventory on
December 31 was 20,000 units, and net income for
PROBLEM NO. 2. the year was P480,000. If Shark had used variable
Luzon Manufacturing Company began its operations on costing, its net income would have been P440,000.
January 1, 2020 and it produces a single product that Compute the breakeven point in units.
sells for P45 per unit. During 2020, 60,000 units of
the product were produced, 55,000 of which were PROBLEM NO. 6.
sold. There was no work in process inventory at the During its first year of operations, Gold, Inc. produced
end of the year. Manufacturing and marketing and 27,000 units. Unit sales were 26,400. Fixed overhead
administrative expenses for 2020 were as follows: was applied at P0.75 per unit produced. Fixed
Fixed Variable overhead was underapplied by P3,000. This fixed
Materials P12 per unit produced overhead variance was closed to Cost of Goods Sold.
Direct labor P8 per unit produced There was no variable overhead variance. The results
Factory OH P420,000 P6 per unit produced of the year’s operations are as follows (on an
Marketing & P180,000 P4 per unit sold absorption-costing basis):
admin.
Sales (26,400 units @ P12) P 316,800
Requirements: Less: Cost of goods sold 161,400
1. Compute the unit cost using variable costing. Gross margin P 155,400
2. Compute the unit cost using absorption costing. Less: Selling and administrative
3. Compute the amount of income under: expenses (all fixed) 120,000
a. Traditional costing Operating income P 35,400
b. Variable costing
c. Throughput costing Requirements:
1. Give the cost of the firm’s ending inventory under
PROBLEM NO. 3. absorption costing. What is the cost of the
RV Corporation has fixed manufacturing cost of P8 per ending inventory under variable costing?
unit. Consider the three independent cases that follow. 2. Prepare a variable-costing income statement.
Case A: Absorption- and variable costing net
income each totaled P160,000 in a period MULTIPLE CHOICE QUESTIONS
when the firm produces 20,000 units.
Case B: Absorption-costing net income totaled 1. If a firm produces more units than it sells,
P180,000 in a period when finished-goods absorption costing, relative to variable costing, will
inventory level rises by 5,000 units. result in
Case C: Absorption-costing net income and a. higher income and assets
variable-costing net income respectively b. lower income but lower assets
totaled P240,000 and P272,000 in a period c. higher income but lower assets
when the beginning finished-goods inventory d. lower income and assets
was 14,000 units.
2. Under absorption costing, if sales remain constant
Requirements: from period 1 to period 2, the company will report a
1. In Case A, how many units were sold during the larger income in period 2 when
period? a. period 2 production exceeds period 1 production
2. In Case B, how much income would RV Company b. period 1 production exceeds period 2 production
report under variable costing?
3. In Case C, how many units were in the ending
finished-goods inventory?

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EXCEL PROFESSIONAL SERVICES, INC.

c. variable production costs are larger in period 2 a. Direct period costs.

than period 1 b. Indirect period costs.
d. fixed production costs are larger in period 2 than c. Direct product costs.
period 1 d. Indirect product costs.

3. The variable costing format is often more useful to 10. Which of the following groups prefer variable
managers than the absorption costing format costing for their reporting?
because A. Internal decision maker
a. costs are classified by their behavior B. Bureau of Internal Revenue
b. it is required for external reporting C. Stockholders
c. costs are always lower D. Securities & Exchange Commission
d. it justifies higher product prices
11. How will a favorable volume variance affect net
4. When a firm prepares financial reports using income under each of the following methods?
absorption costing Absorption Variable
a. profits will always increase with increase in sales a. Reduce No effect
b. profits will always decrease with decreases in b. Reduce Increase
sales c. Increase No effect
c. profits may decrease with increased sales even if d. Increase Reduce
there is no change in selling prices and costs
d. decreased output and constant sales result in 12. Assuming absorption costing, which of the following
increased profits columns includes only product costs?
A B C D
5. Which of the following statements is true for a firm Direct labor X X X
that uses variable costing? Direct materials X X X
a. The cost of a unit of product changes because of Sales materials X
changes in the number of units manufactured Advertising costs X
b. Profits fluctuate with sales Indirect factory materials X X X
c. An idle facility variation is calculated
Indirect labor X X X
d. None of the given choices
Sales commissions X
Factory utilities X X X
6. Net income determined using full absorption costing
Administrative supplies X
can be reconciled to net income determined using
expense
variable costing by computing the difference
between: Administrative labor X
A. fixed manufacturing overhead costs deferred in Depreciation on X
or released from inventories. administration building
B. inventoried discretionary costs in the beginning Cost of research on X
and ending inventories. customer demographics
C. gross margin (absorption costing method) and A. A. C. C.
contribution margin (variable costing method). B. B. D. D.
D. sales as recorded under the variable costing
method and sales as recorded under the 13. Which of the following is(are) closely related to
absorption costing method. variable costing than to absorption costing?
1. Predetermined fixed overhead
7. Which of the following statements is correct? 2. Unit sales
A. When production is higher than sales, absorption 3. Production units
costing net income is lower than variable costing 4. Contribution margin
net income 5. Gross margin
B. If all products manufactured during the period 6. Volume variance
are sold in that period, variable costing net 7. Cost behavior
income is equal to absorption costing net 8. Management accounting
income.
C. When production is lower than sales, variable A. 1, 2, 4, 6, 7, 8
costing net income is lower than absorption B. 2, 4, 7, 8
costing net income C. 1, 3, 4, 7, 8
D. When production and sales level are equal, D. 1, 3, 5, 6
variable costing net income is lower than
absorption costing net income. 14. At its present level of operations, a small
manufacturing firm has total variable costs equal to
8. As compared with total absorption costing profit 75% of sales and total fixed costs equal to 15% of
over the entire life of a company, total variable sales. Based on variable costing, if sales change by
costing profit will be P1.00, income will change by
A. less a. P0.25 c. P0.75
B. greater b. P0.10 d. Undeterminable
C. equal
D. substantially greater or less depending upon 15. Gabbert Company, which has only one product, has
external factors provided the following data concerning its most
recent month of operations:
9. Using absorption costing, fixed manufacturing Units sold @ P90 per unit 3,400
overhead costs are best described as Units produced 3,600
Beginning inventory 0

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EXCEL PROFESSIONAL SERVICES, INC.

19. Company B produces a single product. The

Costs Variable Fixed Cost company had 16,000 units in its beginning
Cost inventory. During the year, the company's variable
Direct materials P23 production costs were P6 per unit and its fixed
Direct labor 11 manufacturing overhead costs were P4 per unit. The
Manufacturing overhead 2 P 93,600 company's net operating income for the year was
Selling and administrative 8 61,200 P24,000 higher under absorption costing than it was
expenses under variable costing. Given these facts, the
What is the total period cost for the month under number of units in the ending inventory must have
the variable costing approach? been:
a. P93,600 a. 22,000 units c. 6,000 units
b. P154,800 b. 10,000 units d. 4,000 units
c. P88,400 20. This year, Roberts Company's income under
d. P182,000 absorption costing was P2,000 lower than its
income under variable costing. The company sold
16. Three new companies (X, Y, and Z) began 8,000 units during the year, and its variable costs
operations on January 1. Consider the following were P8 per unit, of which P2 was variable selling
operating costs that were incurred by these expense. If production cost was P10 per unit under
companies during the complete calendar year: absorption costing, then how many units did the
Company X Company Y Company Z company produce during the year?
Production in A. 7,500 units.
units 10,000 10,000 10,000 B. 7,000 units.
Sales price per C. 9,000 units.
unit P10 P10 P10 D. 8,500 units.
Fixed
production costs P10,000 P20,000 P30,000 21. Southseas Corp. uses a standard cost system. The
Variable standard cost per unit of one of its products are as
production costs P30,000 P20,000 P10,000 follows:
Variable SG&A P10,000 P20,000 P30,000
Direct Materials P4.00
Fixed SG&A P30,000 P20,000 P10,000
Direct labor 6.00
Based on sales of 7,000 units, which company will Factory overhead
report the greater income before income taxes Variable 3.00
under variable costing? Fixed (based on a normal
a. Company X capacity of 10,000 units) 2.00
b. Company Y Total 15.00
c. Company Z
d. All of the companies will report the same income. Beginning inventory 2,000 units
Production 8,000 units
17. A company manufactures a single product for its Units sold (selling price P50) 7,000 units
customers by contracting in advance of production. Actual costs:
Thus, the company produces only units that will be Direct materials P 35,000
sold by the end of each period. For the last period, Direct labor 50,000
the following data were available: Variable overhead 23,000
Sales P40,000 Fixed overhead 18,000
Direct materials 9,050 Variable selling and administrative 60,000
Direct labor 6,050 Fixed selling and administrative 35,000
Rent (9/10 factory, 1/10 office) 3,000
Depreciation on factory equipment 2,000 Variances are closed to cost of sales monthly.
Supervision (2/3 factory, 1/3 office) 1,500 How much are the net income under absorption
Salespeople’s salaries 1,300 costing and variable costing methods?
Insurance (2/3 factory, 1/3 office) 1,200 Absorption Variable
Office supplies 750 a. 144,000 143,000
Advertising 700 b. 143,000 144,000
Depreciation on office equipment 500 c. 144,000 142,000
Interest on loan 300 d. 142,000 144,000
The gross profit margin percentage (rounded) was
a. 34% c. 44% Use the following information for the next two
b. 41% d. 46% questions.
The following data are available for X Co. for its first
18. Lauder Company produces a single product. During year of operations:
March, the company had net operating income Sales in units 5,000
under absorption costing that was P3,500 lower Production in units 8,000
than under variable costing. The company sold Manufacturing costs:
7,000 units in March, and its variable costs were P7 Direct labor P3 per unit
per unit, of which P3 was variable selling expense. Direct materials P5 per unit
If fixed manufacturing overhead was P2 per unit Variable overhead P1 per unit
under absorption costing, then how many units did Fixed overhead P100,000
the company produce during March? Net income (absorption method) P30,000
a. 5,250 units c. 6,500 units Sales price per unit P40
b. 8,750 units d. 6,125 units

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 EXCEL PROFESSIONAL SERVICES, INC.

22. What would X Co. have reported as its income Units produced 20,000
before tax if it had used variable costing? Units sold 12,000
a. P30,000 c. P67,500 Unit sales Price P12
b. P(7,500) d. P45,000
26. What is Cost of Goods Sold for Soconfused Co.’s
23. What was the total amount SG&A expense incurred first year?
by X Co.? a. P80,000 c. P48,000
a. P30,000 c. P6,000 b. P90,000 d. Undeterminable
b. P62,500 d. P45,000
27. If Soconfused Co. had used variable costing in its
Use the following information for the next two questions. first year of operations, how much income (loss)
Sales and costs data for Maripaz Corporation’s new before taxes would they have reported?
product are as follows: a. P(6,000) c. P26,000
Sales (P22.50 per unit) P225,000 b. P54,000 d. P 2,000
Unit Fixed Cost
Variable 28. Based on variable costing, if Soconfused had sold
Cost* 12,001 units instead of 12,000, its income before
Manufacturing cost P12.00 P37,500 taxes would have been
Administrative cost 4.50 22,500 a. P9.50 higher c. P8.50 higher
* per unit of production. b. P11.00 higher d. P8.33 higher
There was no inventory at the beginning of the year.
Normal capacity of the plant is 12,500 units. During the Use the following information for the next two questions.
year, 12,500 units were manufactured. Reusser Company produces wood statues. Management
24. The total fixed cost charged to expense for the year has provided the following information:
under the absorption costing shall be Actual sales 80,000 statues
a. P48,000 Budgeted production 100,000 statues
b. P52,500 Selling price P20.00 per statue
c. P55,500 Direct material costs P5.00 per statue
d P60,000. Variable manufacturing costs P1.50 per statue
Variable administrative costs P2.50 per statue
25. The cost of ending inventory under the direct Fixed manufacturing overhead P2.00 per statue
costing and absorption costing shall be as follows:
a. b. c. d. 29. What is the cost per statue if throughput costing is
Direct costing P30,000 P30,000 P37,500 P37,500 used?
Absorption costing P37,500 P30,000 P30,000 P37,500 a. P11.00 c. P7.50
b. P9.50 d. P5.00
Use the following information for the next three
questions. 30. What is the total throughput contribution?
The following information was extracted from the first a. P1,500,000 c. P720,000
year of absorption-based accounting records of b. P2,000,000 d. P1,200,000
Soconfused Co.
Total fixed costs incurred P100,000
Total variable costs incurred 50,000
Total period costs incurred 70,000
Total variable period costs incurred 30,000

"No one is going to give you a map; you have to walk your own path." - Anonymous

– end -

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