VARIABLE

AND
ABSORPTION
COSTING
Group 2 - AC2A
Table Of Contents

Definition, Principal Differences, and

Computation of Unit Product Cost Under the Two
Methods

Income Statement (Absorption Costing)

Income Statement (Variable Costing)

Table Of Contents

Reconciliation of Net Income Differences

Arguments for and Against Absorption

Costing and Variable Costing

Sensitivity Analysis
Our Team

Titular, Valerio, Zara, Ericka

Grachelle S. Maelene C. Denisse L.
DEFINITION, PRINCIPAL
DIFFERENCES, AND
COMPUTATION OF UNIT
PRODUCT COST UNDER
THE TWO METHODS
Titular, Grachelle S.
Assigning Costs to Products

PRODUCT COSTING
it involves the assignment of costs to the output
produced by the company.

the process of calculating the costs incurred with

manufacturing a single product.
 Product Cost Period Cost

Directly related to Cannot be

the production of assigned to any
goods and products
products
Basis: Time
Basis: Volume
Generally fixed
Generally variable
Product Costing Methods

Variable Costing Absorption Costing

Includes only variable Includes both

costs variable costs and
fixed costs
aka Marginal Costing
or Direct Costing aka Full Costing
For internal reporting For external
purposes reporting
COMPUTATION OF
UNIT PRODUCT
COST AND UNIT
PERIOD COST
Titular, Grachelle S.
Computation of Unit Product Cost

Absorption Costing Variable Costing

Direct Materials $240 $240
Direct Labor $280 $280
Variable MOH $100 $100
Fixed MOH $120* ----
Product Cost $740 $620

*1,200,000 / 10,000 = $120

Computation of Unit Period Cost

Absorption Costing Variable Costing

Fixed MOH --- $120
Variable S & Adm. $40 $40
Fixed S & Adm. $100* $100

Period Cost $140 $260

*800,000 / 8,000 = $100

INCOME STATEMENT
(ABSORPTION
COSTING)
Titular, Grachelle S.
 ABSORPTION COSTING

Also known as the FULL COSTING METHOD.

For external users
In conformity with GAAP
In comparison with the variable costing, there is a
"deferred fixed overhead" cost
 ABSORPTION COSTING
Income Statement
Sales P xxx
Less: Cost of Goods Sold (xxx)
Gross Profit xxx
Less: Operating Expenses (xxx)
Net income P xxx

Product Cost = DM + DL + Variable MOH + Fixed MOH

Operating Expenses = Variable and fixed selling and
administrative expenses
 ABSORPTION COSTING
Pro-forma Income Statement
 PROBLEM 1: ABSORPTION COSTING
Nobita Company makes Doraemon laptop tables that sell for P250 each.
The company's annual production and sales level is 120,000 laptop tables.
In addition to P4,305,000 fixed manufacturing overhead and P1,590,500
fixed administrative expenses, the following per-unit costs have been
determined for each laptop table:
Direct Materials P60.00
Direct Labor P30.00
Variable Manufacturing OH P8.00
Variable Selling Expense P22.00
Total Variable Cost per Unit P120.00
 PROBLEM 1: ABSORPTION COSTING
REQUIRED: Income statement under Absorption Costing
 PROBLEM 2: ABSORPTION COSTING
Nobita Company makes Doraemon laptop tables that sell for P250 each.
The company's annual production and sales level are 120,000 laptop
tables. 100,000 tables were sold. In addition to P4,305,000 fixed
manufacturing overhead and P1,590,500 fixed administrative expenses, the
following per-unit costs have been determined for each laptop table:
Direct Materials P60.00
Direct Labor P30.00
Variable Manufacturing OH P8.00
Variable Selling Expense P22.00
Total Variable Cost per Unit P120.00
 PROBLEM 2: ABSORPTION COSTING
REQUIRED: Income statement under Absorption Costing
INCOME STATEMENT
(VARIABLE
COSTING)
Zara, Ericka Denisse L.
 VARIABLE COSTING
Income Statement
Sales P xxx
Less: Variable Costs (xxx)
Contribution Margin xxx
Less: Fixed Costs (xxx)
Net income P xxx

Manufacturing Costs = Direct Materials + Direct

Labor + Variable Factory Overhead
 VARIABLE COSTING
Also known as the CONTRIBUTION MARGIN
APPROACH

Used in presenting income information to internal

users of accounting information

Not in conformity with GAAP

VARIABLE COSTING
VARIABLE COSTING
 VARIABLE COSTING

Direct materials, direct labor, and all variable

costs are deducted to sales to determine the
contribution margin.

All fixed costs during the period are deducted

against the contribution margin to determine net
income.

FEATURES OF VARIABLE COSTING

Costs are identified as variable costs and fixed

costs, not COGS and OPEX.

Fixed manufacturing overhead is treated as a

period cost and is charged directly of the entire
amount matched against revenues for that
period.

FEATURES OF VARIABLE COSTING

Variable Costing recognizes that only production

costs that vary directly with the volume of
production shall be treated as product cost.
Fixed manufacturing overhead shall become a
period cost since whatever level of production,
they will still be incurred.

PRO-FORMA CONTRIBUTION MARGIN

INCOME STATEMENT
 ILLUSTRATION 1
During the year 2020, Zara Corporation’s production was equal to
its normal capacity of 1,000 units. It sold 900 units at a price of
P50 per unit.

TOTAL COST COST PER UNIT

Direct Materials 12,000 12
Direct Labor 10,000 10
Variable Factory Overhead 8,000 8
Fixed Factory Overhead 6,000 6
Variable Selling and Administrative 4,500 5
Fixed Selling and Administrative 3,000 3
ILLUSTRATION 1

REQUIRED:

1. Product Cost per unit under variable costing

2. Income under Variable Costing
3. Cost of Ending Inventory under Variable Costing

ILLUSTRATION 1

SOLUTION:

1. Product Cost per unit under variable costing

Total Manufacturing Cost = DM + DL +VFOH

= 12 + 10 + 8
= P30 / unit
ILLUSTRATION 1

SOLUTION:
2. Income under Variable Costing
 ILLUSTRATION 1
SOLUTION:
2. Income under Variable Costing

Sales
45,000
Less: Variable Costs
(31,500)
Direct Materials 10,800

Direct Labor 9,000

Variable FOH 7,200

Variable S&A 4,500

Contribution Margin 13,500

ILLUSTRATION 1
Sales
45,000
Less: Variable Costs
(31,500)
Direct Materials 10,800

Direct Labor 9,000

Variable FOH 7,200

Variable S&A 4,500

Contribution Margin

13,500
Less: Fixed Costs

(9,000)
FOH 6,000

FS&A 3,000

Net Income

4,500
ILLUSTRATION 1

SOLUTION:

3. Cost of Ending Inventory under Variable Costing

Cost of Ending Inventory = Ending Inventor * Product Cost

= 100 * 30
= 3,000
CONTRIBUTION MARGIN
RECONCILIATION
OF NET INCOME
DIFFERENCES
Zara, Ericka Denisse L.
Product EQUALS Sales
when production is equal to sales, there is no change in
inventory. Fixed overhead expenses under absorption costing
equal fixed overhead expensed under variable costing.
Therefore, absorption costing income equals variable costing
income.

Production = Sales
Ending inventory = Beginning inventory
Absorption income = Variable income
ILLUSTRATION 1
Cherry Company makes Pikachu laptop tables that sell for P250 each. The
company's annual production and sales level is 120,000 laptop tables. In
addition to P4,305,000 fixed manufacturing overhead and P1,590,500 fixed
administrative expenses, the following per-unit costs have been
determined for each laptop table:
Direct Materials P60.00
Direct Labor P30.00
Variable Manufacturing OH P8.00
Variable Selling Expense P22.00
Total Variable Cost per Unit P120.00
ILLUSTRATION 1
ILLUSTRATION 1
ILLUSTRATION 1
Product is GREATER than Sales
when production exceeds sales, there is an increase in
inventory. Fixed overhead expensed under absorption costing
is less than fixed overhead expensed under variable costing.
Therefore, absorption costing income is greater than variable
costing income.

Production > Sales

Ending inventory > Beginning inventory
Absorption income > Variable income
ILLUSTRATION 2
Nobita Company makes Pikachu laptop tables that sell for P250 each. The
company's annual production level is 120,000 laptop tables. 100,000 were
sold. In addition to P4,305,000 fixed manufacturing overhead and
P1,590,500 fixed administrative expenses, the following per-unit costs have
been determined for each laptop table:
Direct Materials P60.00
Direct Labor P30.00
Variable Manufacturing OH P8.00
Variable Selling Expense P22.00
Total Variable Cost per Unit P120.00
ILLUSTRATION 2
ILLUSTRATION 2
ILLUSTRATION 2
To account for the difference
in net income under the two
methods:
Change in inventory P xxx
Fixed factory overhead cost per unit xxx
Difference in income P xxx
To reconcile the net income
difference under the two
methods:
Absorption costing income P xxx
Add: Fixed overhead in beginning inventory* xxx
Less: Fixed overhead in ending inventory* xxx
Variable costing income P xxx
ILLUSTRATION 2
Fixed Manufacturing Overhead Component of ending
Inventory:

20,000 laptop tables x P 35.875 = P 717,500

Product is LESS than Sales
when production is less than sales, there is a decrease in
inventory. Fixed overhead expensed under absorption costing
is greater than fixed overhead expensed under variable
costing. Therefore, absorption costing income is less than
variable costing income.

Production < Sales

Ending inventory < Beginning inventory
Absorption income < Variable income
 ILLUSTRATION 3
Nobita Company makes Pikachu laptop tables that sell for P250 each. The
company's annual production is 120,000 laptop tables. There were 50,000
unsold laptop tables from last year. 140,000 were sold this year. In addition to
P4,305,000 fixed manufacturing overhead and P1,590,500 fixed administrative
expenses, the following per-unit costs have been determined for each laptop
table:
Direct Materials P60.00
Direct Labor P30.00
Variable Manufacturing OH P8.00
Variable Selling Expense P22.00
Total Variable Cost per Unit P120.00
ILLUSTRATION 3
ILLUSTRATION 3
ILLUSTRATION 3
To account for the difference
in net income under the two
methods:
Change in inventory P xxx
Fixed factory overhead cost per unit xxx
Difference in income P xxx
To reconcile the net income
difference under the two
methods:
Absorption costing income P xxx
Add: Fixed overhead in beginning inventory* xxx
Less: Fixed overhead in ending inventory* xxx
Variable costing income P xxx
ILLUSTRATION 3
Fixed Manufacturing
Overhead Component of
beginning Inventory:
50,000 laptop tables x P
35.875 = P 1,793,750

Fixed Manufacturing
Overhead Component of
ending Inventory:
30,000 laptop tables x P
35.875 = P 1,076,250

 ARGUMENTS FOR
AND AGAINST
VARIABLE COSTING
Valencia, Allyssa
Main Advantages of
Variable Costing System
1. Simplicity
A variable costing system is a simple and
easy method of cost accumulation than
the absorption costing approach.
2. Assists CVP Analysis
It provides essential data and
information for cost volume profit (CVP)
analysis.

3. Cost Separation
It clearly separates manufacturing costs
into fixed costs and variable costs which
simplifies production activities.
4. Relation With Standard Costing
And Budgetary Control
Cost-controlling techniques such as
budgetary control and standard costing
are related with variable costing.

5. Easy Profit Determination

It is very easy to determine profit under
variable costing.
6. Planning and Controlling
Variable costing helps the management
in cost control and profit planning.
Main Disadvantages of
Variable Costing System
1. Ignores Accounting Principles
This method of cost accumulation ignores
generally accepted accounting principles
(GAAP).
2. Difficult to Separate Costs
It is very difficult to separate
manufacturing overhead into variable
costs and fixed costs.

3. Understate of Cost
This method understates the product
cost by excluding fixed costs. So, the fair
cost of production cannot be determined.
4. Unsuitable
Variable costing is useful for internal
reporting only and not suitable for
external reporting.
ARGUMENTS FOR
AND AGAINST
ABSORPTION
COSTING
Valencia, Allyssa
Main Advantages of
Absorption Costing System
1. Fair Pricing
Absorption costing covers both variable
costs and fixed costs while determining
the cost of a unit of a product. So, it is a
suitable method to determine the fair price
of products and services.
2. Importance of Fixed Cost
The absorption costing system recognizes
the importance of fixed manufacturing costs
and treats them as product costs.

3. Easy to Operate
The absorption costing system of
product costing is a simple method that
can be installed and operated easily
without any complication.
4. Accurate Profitability
The absorption costing system helps to
determine accurate profitability in the case of
seasonal production and sales.

5. No Separation of Costs
There is no need to separate costs into
variable costs and fixed costs in this
system.
6. Preparing Final Accounts
Absorption costing helps to prepare the
income statements and final accounts of
the company.
Main Disadvantages of
Absorption Costing
System
1. Not Suitable For Decision Making
Absorption costing does not provide
detailed information about fixed and
variable costs. Therefore, it may not be useful
for management for planning and decision-
making purpose.
2. Not Suitable For Flexible Budget
A flexible budget cannot be prepared with
the help of absorption costing because it does
not make a distinction between fixed and
variable costs.

3. Artificial Profitability
In absorption costing, more profit can be
shown by moving fixed manufacturing costs
from the income statement. It misleads the
users.
SENSITIVITY
ANALYSIS

Valerio, Maelene C.
What is Sensitivity
Analysis?
Sensitivity analysis is a technique that
allows the analysis of changes in
assumptions used in forecasts
Key Questions to Ask in
Business Forecasts
How reliable are the assumptions made?
What happens if assumptions turn out to
be significantly different in reality?
Which assumptions are most significant to
the forecast?
Sensitivity Analysis =
"What-if?" Analysis
Allows key assumptions to be changed to
analyze the effect
Helps judge the degree of risk (e.g. in an
investment project)
Recognizes that there is no such thing as an
accurate forecast
Considers one variable or assumption at a time
Example of Sensitivity Analysis:
Forecast Profit
Managers at Business A are forecasting the profit they hope to
achieve next year based on the following assumptions.
Example of Sensitivity Analysis:
Forecast Profit
Let's start by working out the forecast profit based on the
assumptions.
Example of Sensitivity Analysis: What-if
the Assumptions are Worse by 10%?
We can now isolate each assumption and see how forecast profit
changes (how sensitive it is) to each assumption being 10% worse
Example of Sensitivity Analysis: What-if
the Assumptions are Worse by 10%?
The forecast profit assuming that only one variable is worse than
expected at a time is:
Example of Sensitivity Analysis: What-if
the Assumptions are Worse by 10%?
Let's now see how "sensitive" the resulting profit is to the change
in each assumption (10% worse)
Results of the Sensitivity Analysis
Example
Forecast profit (£200,000) is most sensitive to a fall in
assumed selling price per unit
A 10% lower selling price results in a 50% fall in forecast profit
(other assumptions remaining constant)
The next most significant assumption is sales volume, where a
10% shortfall would result in a 35% reduction in forecast profit
Benefits and Drawbacks of Sensitivity
Analysis

BENEFITS
Identifies the most significant assumptions (which therefore
require closer attention)
Helps assess risk and prepare for a less- than-favorable
scenario
Helps make the process of business forecasting more robust
Benefits and Drawbacks of Sensitivity
Analysis

DRAWBACKS
Only tests one assumption at a time (many assumptions may
be linked)
Only as good as the data on which forecasts are based
A somewhat complicated concept – not understood by all
managers
THANK YOU!
-Group 2- AC2A

Subject: Financial Management 2