ABSORPTION & VARIABLE COSTING WITH PRICING DECISIONS

ABSORPTION COSTING (AC) VARIABLE COSTING (VC)

1. Other Names Full Costing, GAAP Costing Direct Costing, Marginal Costing
2. Treatment of FFOH Product Cost -- Inventory, then Expense Period Cost -- Fully Expensed in the Period Incurred
3. Reason behind Treatment FFOH is necessary to produce units FFOH is incurred with or without production
4. Product Cost Components DM, DL, VFOH & FFOH DM, DL & VFOH
5. Period Cost Items Selling & Administrative Expenses FFOH, Selling & Administrative Expenses
6. Inventory Cost Higher than Variable Costing’s Lower than Absorption Costing’s
7. Income Statement Format Functional Presentation (“CGS” Format) Behavioral Classification (“CM” Format)
8. Main Purpose/Function External Financial Reporting Management Decision Aid – for internal use
9. Common Applications Financial Statements, Reporting to BIR & SEC CVP Analysis, Pricing Decision, Relevant Costing
10. Main Criticism Possibility of Income Manipulation Violation of Matching Principle
Where: FFOH – Fixed Factory Overhead DM – Direct Materials CGS – Costs of Goods Sold
VFOH – Variable Factory Overhead DL – Direct Labor CM – Contribution Margin
 Under AC, FFOH costs are initially inventoried and expensed (part of CGS) only when related units are sold.
 Under VC, FFOH costs are fully expensed in the period incurred (i.e., outright expense regardless of sales).
 AC Profit vs. VC Profit:
Situation Implication Explanation
Since Ending Inventory > Beginning Inventory:
1 Production > Sales AC Profit > VC Profit FFOH expensed under AC is lower than to FFOH expensed under VC
Since Ending Inventory = Beginning Inventory:
2 Production = Sales AC Profit = VC Profit FFOH expensed under AC is equal to FFOH expensed under VC
Since Ending Inventory < Beginning Inventory:
3 Production < Sales AC Profit < VC Profit FFOH expensed under AC is higher than FFOH expensed under VC

∆ Profit = ∆ Inventory x unit FFOH

Where: ∆ Profit = AC Profit – VC Profit
∆ Inventory = Ending Inventory – Beginning Inventory = Production – Sales
Unit FFOH = Total FFOH ÷ Production in Units
 Profit under VC fluctuates with sales (not production); production influences profit under AC (not under VC).
PRICING DECISIONS refer to the process of the setting the selling price of a product and/or service.
 Major factors that influence pricing decisions [The 3 C’s]:
1. CUSTOMERS – Customers’ preference and willingness to pay is largely affected by the product’s price.
2. COMPETITORS – A product’s price is affected by competitor’s pricing for substitute products.
3. COSTS – Lower production costs allow a company to charge a competitive price for its product.
In general, the price of a product is dependent upon its demand and supply. The value that customers place
on the product and the prices competitors charge for competing products affect DEMAND, while the costs of
producing and delivering the product influence SUPPLY.
[Law of supply and demand shall be covered in MS-09 (Economics)]
 General pricing approaches:
1. VALUE-BASED – prices are based on buyer’s perception of product value instead of on seller’s costs.
2. COMPETITION-BASED – prices are mainly influenced by the price of competing products.
A) Going-rate pricing: price = competitor’s price
B) Bidding (sealed-bid pricing): price = lowest price among bidders
C) Target costing: In target costing, selling price is usually known before the product is developed.
➢ Step 1 – Market price is given or determined by considering competition and customers.
➢ Step 2 – Target cost is computed based on formula:
Target Cost = Market Price – Desired Profit
➢ Step 3 – Life-cycle costs are reduced to reach the target cost level by doing value engineering.
[Value engineering & life-cycle costs shall be covered in MS-14 (Various Topics in Management Services)]
➢ Step 4 – Product is dropped if cost-cutting measures do not bring costs down to target levels.
3. COST-BASED – prices shall cover value-chain costs and provide the desired return on investment.
A) Cost-plus pricing: price = certain costs + target profit
B) Mark-up pricing: price = full costs + target percentage on costs or selling price
4. Other pricing strategies:
A) Price Skimming – setting an introductory price relatively high to attract non-price-sensitive buyers
so that the firm may recover its research and development costs.
B) Penetration Pricing – setting an introductory price relatively low to gain deep market penetration.
C) Predatory Pricing – an illegal scheme where products are priced below cost to destroy competitors.
• Price adjustment strategies:
1. Cash Discounts – offered to encourage prompt payment of customer dues (e.g., 2/10, n/30).
2. Volume Discounts – offered to customers who purchase in large quantities.
3. Seasonal Discounts – offered to encourage sale and stabilize production of out-of-season products.
4. Functional Discounts – offered to members of trade channel for performing tasks such as selling.
5. Allowances – price reductions that can take the form of a trade-in or promotional allowance.
 EXERCISES: ABSORPTION & VARIABLE COSTING with PRICING DECISIONS
1. ABSORPTION COSTING vs. VARIABLE COSTING
Twice Company makes a single product that sells for P 2,000 each. Data for 2023’s operations follow:
Units: Variable Costs:
Beginning Inventory 5 Direct Materials P 30,000
Production 50 Direct Labor 15,000
Ending Inventory 15 Factory Overhead 5,000
Selling and Administrative 6,000
Fixed Costs:
Factory Overhead P 25,000
Selling and Administrative 4,000
REQUIRED:
1. Determine the inventory cost per unit under:
A) Absorption costing B) Variable costing
2. Determine the total cost of ending inventory under:
A) Absorption costing B) Variable costing
3. Prepare the income statement under:
A) Absorption costing B) Variable costing
4. Without knowing the exact amounts of profit under absorption costing & variable costing:
A) How much is the difference in profit?
B) Which costing method produces the higher profit?
SOLUTION GUIDE to requirement 3

3A) ABSORPTION Costing 3B) VARIABLE Costing

Sales P Sales P
- Costs of Sales - Variable Costs
Gross Profit P Contribution Margin P
- Expenses - Fixed Costs
Net Income P Profit P
2. COST-PLUS PRICING: ABSORPTION approach vs. CONTRIBUTION approach
Blackpink Company has provided the following data for one of its products:
Direct materials P 8.00
Direct labor 7.00
Variable manufacturing overhead 2.00
Variable SG&A expenses 3.00
The company produces and sells 15,000 units of this product each year. Fixed manufacturing overhead
cost total P 15,000 per year and fixed SG&A expenses total P 30,000 per year.

A) If company uses the absorption approach to pricing and desires a 50% markup, then what is the target
selling price per unit?
a. P 34.50 c. P 27.00
b. P 31.50 d. P 23.00
B) If company uses the contribution approach to pricing and desires a 35% markup, then what is the
target selling price per unit?
a. P 29.70 c. P 22.95
b. P 27.00 d. P 20.00

3. MARK-UP PRICING
Red Velvet Company started operations on January 1, 2022 and expected to produce 200,000 units in its
first year of operations. The cost data per unit based on expected production are shown below:
Direct materials P 48.00
Direct labor P 12.00
Variable overhead P 6.00
Variable selling and admin. expense P 3.50
Fixed overhead P 3.00
Fixed selling and admin. expense P 2.50
Red Velvet Company is trying to decide on what selling price that they will use to project the 2022 sales.
REQUIRED: Determine the unit selling price under each of the following cases:
1. 5% mark-up based on prime costs.
2. 10% mark-up based on conversion costs.
3. 20% mark-up based on variable production costs.
4. 30% mark-up based on variable costs
5. 20% mark-up based on full absorption costs.
6. 10% mark-up based on full costs.
7. Assuming Red Velvet has excess capacity after 200,000 units and an offer to buy 20,000 units by
a local buyer is received, what is the minimum selling price on this offer if no selling and
administrative costs will be incurred, except for P 2 per unit for shipping?
 SELF-TEST QUESTIONS - with suggested answers
(Sources: CMA/CIA/RPCPA/AICPA/Various test banks)
1. What is the costing method that treats all fixed costs as period costs?
C a. Absorption costing c. Variable costing
b. Job-order costing d. Process costing
2. Which method of inventory costing treats direct manufacturing costs and manufacturing overhead costs, both variable
and fixed, as inventoriable costs?
B a. Conversion costing c. Variable costing
b. Absorption costing d. Direct costing
3. A basic tenet of direct costing is that period costs should be currently expensed. What is the rationale behind this?
D a. Period costs are uncontrollable and should not be charged to a specific product
b. Allocation of period costs is arbitrary at best and could lead to erroneous decisions by management
c. Period costs are generally immaterial in amount and the cost of assigning the amount to specific products
would outweigh the benefits
d. Period costs will occur whether or not production occurs and so it is improper to allocate these costs to
production and defer a current cost of doing business
4. Black Co.’s 2023 fixed manufacturing overhead costs totaled P 100,000 and variable selling costs totaled P 80,000. Under
direct (variable) costing, how should these costs be classified?
Period Costs Product Costs
D a. P0 P 180,000
b. P 80,000 P 100,000
c. P 100,000 P 80,000
d. P 180,000 P0
5. Under variable costing,
B a. Net income will tend to move based on changes in levels of production
b. Inventory costs will always be lower than under absorption costing
c. Net income will always be higher than under absorption costing
d. Net income will tend to vary inversely with production changes
6. White Company had the following costs for 2023:
Raw materials P 700,000 Rent for factory building P 50,000
Direct labor 100,000 Rent for sales office 30,000
Miscellaneous FOH (fixed) 80,000 Depreciation on store equipment 20,000
Depreciation on machines 40,000
How much of these costs should be inventoried under absorption (A) and variable (V) costing methods?
C a. (A) 1,020,000 (V) 880,000 c. (A) 970,000 (V) 800,000
b. (A) 1,000,000 (V) 880,000 d. (A) 930,000 (V) 800,000
7. White Company manufactures a single product and has the following cost structure:
Variable costs per unit:
Direct materials P3
Direct labor 4
Variable manufacturing overhead 1
Variable selling and administrative expense 2
Fixed costs per month:
Fixed manufacturing overhead P 100,000
Fixed selling and administrative 60,000
The company produces 20,000 units each month. The unit product cost under absorption costing
C a. P 10 c. P 13
b. P 12 d. P 15
8. Refer to the data in No. 7, what is the unit product cost under variable costing?
A a. P 8 c. P 11
b. P 10 d. P 13
9. Refer to the data in No. 7, assuming there are no beginning inventories, 20,000 units are produced and 19,000 units are
sold in a month. If the unit selling price is P 20, what is the net income under absorption costing?
B a. P 30,000 c. P 38,000
b. P 35,000 d. P 42,000
10. Refer to the data in No. 7 assuming there are no beginning inventories and 20,000 units are produced and 19,000 units
are sold in a month. If the unit selling price is P 20, what is the net income under variable costing?
A a. P 30,000 c. P 38,000
b. P 35,000 d. P 42,000
 11. The use of variable costing requires knowing
D a. The controllable and non-controllable components of all costs
b. The number of units of each product produced during the period
c. The contribution margin and break-even point for all the units produced
d. The variable and fixed components of production costs
12. Brown Company began its operations on January 1, 2023, and produces a single product that sells for P 10 per unit.
Brown uses an actual (historical) cost system. In 2023, 100,000 units were produced and 80,000 units were sold. There
was no work-in-process inventory at December 31, 2023. Manufacturing costs and selling and administrative expenses
for 2023 were as follows:
Fixed costs Variable costs
Raw materials - P 2.00 per unit produced
Direct labor - P 1.25 per unit produced
Factory overhead P 120,000 P 0.75 per unit produced
Selling and administrative 70,000 P 1.00 per unit sold
What would be Brown’s operating income for 2023 under variable (direct) costing method?
B a. P 114,000 c. P 234,000
b. P 210,000 d. P 330,000
Items 13 and 14 are based on the following information
Pink company manufactures and sells a single product. Planned and actual production in its first year of operation was
100,000 units. Planned and actual costs for that year were as follows:
Manufacturing Non-manufacturing
Variable P 600,000 P 500,000
Fixed 400,000 300,000
The company sold 85,000 units of product at a selling price of P 30 per unit.
13. Using absorption costing, the company’s operating profit was
B a. P 750,000 c. P 975,000
b. P 900,000 d. P 1,020,000
14. Using variable costing, the company’s operating profit was
B a. P 750,000 c. P 915,000
b. P 840,000 d. P 975,000
15. Income under absorption costing may differ from income under variable costing. How is this difference calculated?
A a. Change in the quantity of units in inventory times the fixed factory overhead rate per unit
b. Number of units produced during the period times the fixed factory overhead rate per unit
c. Change in the quantity of units in inventory times the variable manufacturing cost per unit
d. Number of units produced during the period times the variable manufacturing cost per unit
16. Blonde, Inc. manufactured 7,000 units last year. The ending inventory consisted of 100 units. There was no beginning
inventory. Variable manufacturing costs were P 6.00 per unit and fixed manufacturing costs were P 2.00 per unit. What
would be the change in the peso amount of ending inventory if variable costing was used instead of absorption costing?
D a. P 800 decrease c. P 0
b. P 200 increase d. P 200 decrease
17. When production exceeds sales, fixed manufacturing overhead costs
B a. Are released from inventory under absorption costing
b. Are deferred in inventory under absorption costing
c. Are released from inventory under variable costing
d. Are deferred in inventory under variable costing
18. During its first year of operations, a company produced 275,000 units and sold 250,000 units. The following costs were
incurred during the year:
Variable costs per unit
Direct materials P 15.00
Direct labor 10.00
Manufacturing overhead 12.50
Selling and administrative 2.50
Total fixed cost
Manufacturing overhead P 2,200,000
Selling and administrative P 1,375,000
The difference between absorption costing profit and variable costing profit is that absorption costing profit is:
A a. P 200,000 greater c. P 325,000 greater
b. P 220,000 greater d. P 62,500 less
19. What best accounts for profit difference between absorption costing and variable costing method?
D a. Difference in fixed costs incurred c. Difference in sales revenue
b. Difference in variable costs incurred d. Difference in inventory valuation
20. Lavender Company’s income under absorption costing was P 3,600 lower than its income under variable costing. The
company sold 10,000 units during the year, and its variable costs were P 9 per unit, P 1 of which represents the variable
selling expense. If production cost was P 11 per unit under absorption costing, then how many units did the company
produce during the year?
B a. 8,200 units c. 11,200 units
b. 8,800 units d. 11,800 units
21. Variable costing and absorption costing will show the same incomes when there are no
D a. Beginning inventories c. Variable costs
b. Ending inventories d. Beginning and ending inventories
 22. Absorption costing and variable costing differ in that
C a. Standards can be used with absorption costing, but not with variable costing.
b. Absorption costing inventories are more correctly valued.
c. Production influences income under absorption costing, but not under variable costing.
d. Companies using absorption costing have lower fixed costs.
23. When sales are constant but production fluctuates,
D a. Net income will be erratic under variable costing
b. Absorption costing will always show a net loss
c. Variable costing will always show a positive net income
d. Net income will be erratic under absorption costing
24. Red Co. had the same activity in 2023 as in 2022, except that production was higher in 2023 (vs. 2022). Red will show
C a. Higher income in 2023 than in 2022
b. The same income in both years
c. The same income in both years under variable costing
d. The same income in both years under absorption costing
25. Violet Company manufactures a single product. Unit variable production costs are P 20 & fixed production costs are
P150,000. Violet uses a normal activity of 10,000 units to set its standard costs. Violet began the year with no inventory,
produced 11,000 units, & sold 10,500 units. What is the ending inventory under absorption costing?
C a. P 10,000 c. P 17,500
b. P 15,000 d. P 20,000
26. Purple Company’s production facility has an ideal capacity of 12,500 units, which was used as the basis for the normal
capacity of 10,000 units. The company was able to produce 11,000 units during the period. Fixed manufacturing costs
were P 200,000 while variable manufacturing costs were also P 200,000. What was the volume or capacity variance for
the production?
B a. P 20,000 unfavorable c. P 24,000 favorable
b. P 20,000 favorable d. P 40,000 favorable
27. Super variable costing treats which of the following costs as the only variable and product costs?
B a. Direct labor c. Straight-line depreciation of factory machine
b. Direct materials d. Supervisory salary of an assembly line manager
28. Super variable costing is sometimes referred to as
D a. Full costing c. Indirect costing
b. GAAP costing d. Throughput costing
29. It is the expected market price for a product or service, considering the consumers’ perception of value and the
competitors’ responses.
B a. Transfer price c. Cost-based price
b. Target price d. Selling price
30. Based on the following information: volume of production – 10,000 units; capital employed – P 60,000; cost to produce
and sell – P 5.00 per unit. The unit selling price that will yield a 20% return on investment is:
B a. P 5.10 c. P 7.00
b. P 6.20 d. P 7.01
31. Magenta Company plans to introduce a new product. To compete effectively, the product could not be priced at more
than P 30. The company requires a return on investment of 15% on all new products. The plan is to produce and sell
25,000 units a year. If the product requires a P 500,000 investment, then target cost should be:
A a. P 27.00 c. P 21.50
b. P 23.00 d. P 20.00
32. Based on sales of 500 units per year, a new product has estimated traceable costs of P 990,000. What is the target price
to obtain a 15% profit margin on sales?
A a. P 2,329 c. P 1,980
b. P 2,227 d. P 1,935
33. Cyan Co. signed a government construction contract providing for a formula price of actual cost plus 10%. In addition,
Cyan was to receive one-half of any savings resulting from the formula price being less than the target price of
P2,200,000. Cyan’s actual costs incurred were P 1,920,000. How much should Cyan receive from the contract?
C a. P 2,060,000 c. P 2,156,000
b. P 2,112,000 d. P 2,200,000
34. Fuchsia Company is introducing a new product. It priced the new product low enough to generate excitement. Which
one of the following pricing approaches did management implement?
B a. Price skimming c. Cost-based pricing
b. Penetration pricing d. Market-based pricing
35. A manufacturing firm intentionally priced its product below cost to eliminate competition. It has a reasonable prospect
of recovering the resulting loss through higher prices once competition is eliminated or through a greater share in the
market. The manufacturing firm has engaged in:
B a. Price discrimination c. Collusive pricing
b. Predatory pricing d. Black market pricing
36. Functional discounts are offered to
D a. Encourage large volume purchases {volume discount}
b. Encourage prompt payment, improve cash flows and avoid bad debts {cash discount}
c. Encourage sale and stabilize production of out-of-season products {seasonal discount}
d. Other members of the marketing channel for performing certain services such as sales and marketing