STRATEGIC MANAGEMENT

TOPIC 3
VARIABLE COSTING VERSUS ABSORPTION COSTING
VARIABLE COSTING
(A.K.A. VC, DIRECT COSTING, MARGINAL COSTING)
A variable costing is a costing system under which those costs of production that vary with output are treated as
product costs. This type of costing is best describe on the following key features.
1. Variable costing is an alternative for internal management reports.
2. Under variable costing, product costs include only the variable manufacturing cost and therefore
inventoriable:
• Direct Materials (DM)
• Direct Labor (DL), unless stated as fixed
• Variable Factory Overhead (VFOH)
3. Under variable costing, the following costs are treated as period expenses and are excluded from product
costs:
• Fixed Factory Overhead (FFOH)
• Variable Selling and Administrative costs
• Fixed Selling and Administrative costs
ABSORPTION COSTING
(A.K.A. AC, FULL COSTING, CONVENTIONAL COSTING)
Absorption costing is a costing system which treats all costs of production as product costs, regardless whether
they are variable or fixed. This type of costing is best described on the following key features:
1. Absorption costing is required for external financial reports and for tax reporting.
2. Under absorption costing, product costs include all manufacturing costs:
• Direct materials (DM)
• Direct Labor (DL)
• Variable Factory Overhead (VFOH)
• Fixed Factory Overhead (FFOH)
3. Under absorption costing, the following costs are treated as period expenses and are excluded from product
costs:
• Variable Selling and Administrative costs
• Fixed Selling and Administrative costs
 REVIEW ON
PRODUCT AND
PERIOD COSTS
VARIABLE COSTING VERSUS ABSORPTION COSTING
RELATIONSHIP OF VARIABLE AND ABSORPTION COSTING

1. When production equals to sales, net income in both costing systems

will have the same amount.
2. Difference in net income between the two methods are due to the
deferral of inventory costs (timing difference), but over time, when
production eventually equals to sales, net income will be the same.
3. Effects when production is not equal to sales:
a. Production > Sales Inventory increases
ANI > VNI
b. Production < Sales Inventory decreases
ANI < VNI
 SAMPLE
PROBLEMS
PROBLEM 1
De Chavez Company produces a single product with the following information available:
Number of units produced annually 25,000
Cost per year
DM 6
DL 3
VFOH 1
VS&A 3
FFOH P150,000
FS&A 100,000
20,000units were sold during the year at a price of P30 each. There were no units in beginning inventory.
Required:
1. Unit product cost using both Variable and Absorption Costing
2. Net operating income using both Variable and Absorption Costing
3. Reconciliation of Variable Net Income and Absorption Net Income
SOLUTION
1. Computation of Product Cost per unit

Notes:
a) Selling and administrative expenses are always treated as period costs and deducted from revenue as incurred.
b) If selling and administrative expense is silent about the segregation of cost, all S&A expense is considered as
fixed.
c) FFOHU = FFOH/ No. of production
SOLUTION
2. Computation of net operating income
SOLUTION
3. Reconciliation of Net Income
We can reconcile the difference between variable and absorption income as follows:

Absorption Net Income (ANI) P 120,000

Add: Deferred Inventory, Beg. (Inv. Beg units x FFOHU) 0
Total 120,000
Less: Deferred Inventory, End. (Inv. End. units x FFOHU)
(5,000 X (P150,000/25,000)) 30,000
Variable Net Income (VNI) 90,000
SOLUTION
3. Reconciliation of Net Income
We can reconcile the difference between variable and absorption income as follows:

Absorption Net Income (ANI) P 120,000

Add: Deferred Inventory, Beg. (Inv. Beg units x FFOHU) 0
Total 120,000
Less: Deferred Inventory, End. (Inv. End. units x FFOHU)
(5,000 X (P150,000/25,000)) 30,000
Variable Net Income (VNI) 90,000
PROBLEM 2
Dominic Corporation has the following standard costs associated with the manufacture and sale of one of its products:
Direct material P 3.00 per unit
Direct labor 2.50 per unit
Variable manufacturing overhead 1.80 per unit
Fixed manufacturing overhead 4.00 per unit (based on an estimate of 50,000 units per year)
Variable selling expenses 0.25 per unit
Fixed SG&A expense P 75,000 per year

During its first year of operations Dominic manufactured 51,000 units and sold 48,000 The selling price per unit was P25. All
costs were equal to standard.
Under absorption costing, the standard production cost per unit for the current year is:
Under variable costing, the standard production cost per unit for the current year is:
Based on variable costing, the income before income taxes for the year is:
SOLUTION
PROBLEM 3
The following information is available for Cardo Company for its first year of operations:
Sales in units 5,000
Production in units 8,000
Manufacturing costs:
Direct labor P 3 per unit
Direct material 5 per unit
Variable overhead 1 per unit
Fixed overhead 100,000
Net income (absorption method) 30,000
Sales price per unit 40

If the Company had used variable costing, what amount of income before income taxes.
If the Company were using variable costing, what would it show as the value of ending inventory?
SOLUTION
PROBLEM 4
Dimapilis Corporation produces a single product. The following cost structure applied to its first year of operations:
Variable costs:
SG&A P 2 per unit
Production 4 per unit
Fixed costs (total cost incurred for the year):
SG&A P 14,000
Production 20,000

1. Assume for this question only that during the current year, the corporation manufactured 5 000 units and sold 3,800. There
was no beginning or ending work-in-process inventory. How much larger or smaller would the Corporation's income be if it
uses absorption rather than variable costing?

2. Assume for this question only that the Corporation manufactured and sold 5,000 units in the current year. At this level of
activity, it had an income of P30,000 using variable costing. What was the sales price per unit?
PROBLEM 4
Dimapilis Corporation produces a single product. The following cost structure applied to its first year of operations:
Variable costs:
SG&A P 2 per unit
Production 4 per unit
Fixed costs (total cost incurred for the year):
SG&A P 14,000
Production 20,000

3. Assume for this question only that the Corporation produced 5,000 units and sold 4,500 units in the current year. If the
company uses absorption costing, it will deduct period costs of:

4. Assume for this question only that the Corporation manufactured 5,000 units and sold 4,000 in the current year. If the company
employs a costing system based on variable costs, the company will end the current year with a finished goods inventory
amounting to:
SOLUTION
THANK YOU!