L01: Inventory costing methods:

- Absorption costing:
- Job is assigned the costs of DM, DL, and both VOH, and FOH
- AKA full costing
- Required for external reporting
- All manufacturing costs are charged to or absorbed by the product
- Absorbtion costing is the approach required for external reporting under GAAP
- FMOH are deferred to a future period as part of the cost of ending inventory
- Both variable and fixed selling and administrative expenses are treated as period costs
and are therefore expensed in the year
- Should show higher net income tha variable constant whenever there are more units
produced then sold

- Variable Costing:
- Only DM, DL, VOH are considered product costs
- Companies using variable costing recognie FMOH as the period costs when incurred
- Companies may NOT use Variable costing for external financial reports because GAAP
require the FOH to be accounted for as a product cost
- FMOH of the current period are not deferred to future periods through ending inventory

- When units produced > units sold → income under absorption costing is higher
- When units produced = units sold → net income will be equal under both methods

L02: Net Income Effects:

Example: Units produced = Units sold
- Net income is equal under both approaches
- No increase in ending inventory, no FMOH costs in the year are deferred to future periods
Example: Units produced > Units sold:
- Net income is higher under absorption costing
- Cost of ending invensoty is higher under absorption than variable costing
- Under absorption costing, FMOH is deferred and carried forward as part of inventory
- Under variable costing, the FMOH is expensed in the current period
Example: Units produced < Units sold:
- FMOH costs in beginning inventory are charged under absorption costing

Summary of net income effects:

L03: Decision Making concerns:
GAAP requires companies to use absorption costing for the costing of inventory:
- Net income measured under GAAP (absorbtion costing) is often used internally to evaluate
performance, justify cost reduction, or assess new projects
- Some companies have recognized that net income calculated using GAAP does not highlight the
differences between VC and FC, and may lead to poor business decisions

Performance Evaluation:
- When production exceeds sales, absorption costing reports a higher net income than variable
costing
- The reason is that some fixed manufacturing costs are not expensed in the same period, but are
deferred to future periods

Potential advantages of Variable Costing:

1) The use of variable costing is consistent with CVP and Incremental Analysis
2) Net income calculated under VC is NOT affected by changes in production levels → much easier
to understand the impact of fixed and VC on the calculation of NI when using variable costing
3) Net income calculated under VC is greatly affected by changes in sales levels and therefore
provides a more realistic assessment of the company’s success or failure during a period
4) Because fixed cost and variable cost components are shown in the variable costing income
statement, it is easier to identify these costs and understand their effect on the business

L04: Normal-Absorption Costing:

- Uses actual direct manufacturing costs and actual production units within a prefermined overhead
rate → More practical for assigning fixed manufacturing OH costs to production
L05: Throughput Costing:
Overview:
- Also called super-variable costing
- Based on lean manufacturing principles → reduces buildup of excess inventories
- Treats all costs as period expenses except for DM
- Modified form of a variable costing system that treats DL and VMOH as period expenses
- According to lean manufacturing principles, cost can be reduced and profitability increased by
improvements in the manufacturing workflow
- The process is being increasingly used by many firms to manage their operations more efficiently
and with more control because it eliminates waste and focuses more accurately on the customer’s
needs
Criteria:
1) Only suitable for companies engaged in a manufacturing process in which conversion costs such
as DL and MOH are fixed and do not vary
2) Management must favour cost accounting information that is helpful for short-term incremental
analysis such as whether the company should accept or reject a special offer at a reduced sales
price
- Choice of throughput costing is a logical extension of its choice of variable over
absorption costing
- Product costs are only DM costs
- Inventory is valued using only DM costs and all other manufacturing costs are treated as
expenses in the accounting period they occur

Summary of income effects:

Advantages of Throughput Costing:
- Reduces incentive for management to build up excess inventories in order to spread fixed
manufacturing costs over a larger number of units produced
- Encourages managers to reduce operating costs such as DL and VMOH which are treated as
period costs NOT product costs