Variable Costing: A

Tool for Management

 Absorption Costing

Treats all manufacturing costs as product

costs, and non-manufacturing costs as period
costs
Unit costs consist of direct material and direct
labor and both variable and fixed
manufacturing overhead.
Fixed manufacturing overhead is allocated to
each unit of production
GAAP

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 Variable Costing

Only those costs of manufacturing that vary

with output (variable costs) are treated as
product costs
This would include direct material, direct labor
and variable manufacturing overhead
Fixed manufacturing overhead is expensed
during the current period
Variable costing is used for internal planning
and control only; it’s not GAAP!

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 Overview of Absorption and
Variable Costing
Absorption Variable
Costing Costing
Direct Materials
Product
Product Direct Labor
Costs
Costs Variable Manufacturing Overhead

Fixed Manufacturing Overhead

Period
Period Variable Selling and Administrative Expenses
Costs
Costs Fixed Selling and Administrative Expenses

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 Variable versus Absorption
costing
They are the
Absorption
numbers that
costing product costs appear on our
are misleading for external
decision making. reports.

Variable Absorption
Costing Costing

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 Example : Weber Light Aircraft
Per Aircraft Per Month

Selling price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $100,000

Direct materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $19,000
Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $5,000
Variable manufacturing overhead . . . . . . . . . . . . . .$1,000
Fixed manufacturing overhead . . . . . . . . . . . . . . . . $70,000
Variable selling and administrative expenses . . . . $10,000
Fixed selling and administrative expenses . . . . . . $20,000

January February March

Beginning inventory . . . . . . . . . 0 0 1
Production . . . . . . . . . . . . . . . . . 1 2 2
Sales . . . . . . . . . . . . . . . . . . . . . . 1 1 3
Ending inventory . . . . . . . . . . . 0 1 0
 Absorption Costing Unit Product Cost
January February March

Direct materials . . . . . . . . . . . . . . . . . . . . . . . . . .$19,000 $19,000 $19,000

Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5,000 5,000 5,000
Variable manufacturing overhead . . . . . . . . . . 1,000 1,000 1,000
Fixed manufacturing overhead ($70,000
1 unit produced in January;
$70,000 2 units produced in
February;
$70,000 2 units produced in March) 70,000 35,000 35,000
Absorption costing unit product cost . . . . . $95,000 $60,000 $60,000
 Absorption Costing Cost of Goods Sold
January February March

Absorption costing unit product cost (a) . . . . $95,000 $60,000 $60,000

Units sold (b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1 3*
Absorption costing cost of goods sold (a) (b) $95,000 $60,000
$180,000

* One of the three units sold in March was produced in February. Since February and
March both have unit product costs of $60,000, the March unit product cost of $60,000
can be multiplied by 3.
 Selling and Administrative Expenses
January February March

Variable selling and administrative expense

(@ $10,000 per unit sold) . . . . . . . . . . . . . . $10,000 $10,000 $30,000
Fixed selling and administrative expense . . . . 20,000 20,000 20,000
Total selling and administrative expense . . . . . $30,000 $30,000 $50,000

Absorption Costing Income Statements

January February March

Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $100,000 $100,000 $300,000

Cost of goods sold . . . . . . . . . . . . . . . . . . . . 95,000 60,000 180,000
Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . 5,000 40,000 120,000
Selling and administrative expenses . . . . . 30,000 30,000 ___ 50,000
Net operating income (loss) . . . . . . . . . . . . $ (25,000) $ 10,000 $ 70,000
 Variable Costing Unit Product Cost
Direct materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $19,000
Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000
Variable manufacturing overhead . . . . . . . . . . . . . . . . . . . . .1,000__
Variable costing unit product cost . . . . . . . . . . . . . . . . . . . . .$25,000

Variable Costing Cost of Goods Sold

January February March

Variable production cost (a) . . . . . . . . . . . . . . . $25,000 $25,000 $25,000

Units sold (b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1 3
Variable cost of goods sold (a) * (b) . . . . . . . . . . $25,000 $25,000 $75,000
 Variable Costing Contribution Format Income Statements
January February March

Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $100,000 $100,000 $300,000

Variable expenses:
Variable cost of goods sold . . . . . . . . . . . . . 25,000 25,000 75,000
Variable selling and administrative
expense . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000 10,000 30,000
Total variable expenses . . . . . . . . . . . . . . . . . . 35,000 35,000 105,000
Contribution margin . . . . . . . . . . . . . . . . . . . . . 65,000 65,000 195,000

Fixed expenses:

Fixed manufacturing overhead . . . . . . . . . . 70,000 70,000 70,000

Fixed selling and administrative expense . . 20,000 20,000 20,000
Total fixed expenses . . . . . . . . . . . . . . . . . . . . 90,000 90,000 90,000__
Net operating income (loss) . . . . . . . . . . . . . . $ (25,000) $ (25,000) $105,000
 Fixed Manufacturing Overhead Deferred in, or Released from,
Inventories under Absorption Costing
January February March
Fixed manufacturing overhead in
beginning inventories . . . . . . . . . . . . . . . . . . . . $0 $0 $ 35,000
Fixed manufacturing overhead in ending
inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 35,000 0___
Fixed manufacturing overhead deferred in
(released from) inventories . . . . . . . . . . . . . $0 $35,000
$(35,000)

Reconciliation of Variable Costing and Absorption Costing Net

Operating Incomes
January February March

Variable costing net operating income . . . . . $(25,000) $(25,000) $105,000

Add (deduct) fixed manufacturing
Overhead deferred in (released from)
Inventory under absorption costing . . . . . . 0 35,000
(35,000)
Absorption costing net operating income . $(25,000) $ 10,000 $ 70,000
 Summary

Relation between Effect Relation between

production on variable and
and sales iniventory absorption income
Inventory Absorption
Production > Sales increases >
Variable
Inventory Absorption
Production < Sales decreases <
Variable
Absorption
Production = Sales No change =
Variable
 Advantages of the Variable
Cost Approach
Consistent with
Management finds it CVP analysis.
easy to understand.

Can be used for marginal

Cost analysis.
Advantages
Easier to estimate profitability
of products and segments.

Impact of fixed
Profit is not affected by
costs on profits
changes in inventories.
emphasized.
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 Variable versus
Absorption Costing
All manufacturing Fixed costs are
costs must be assigned
not really the costs
to products to properly
match revenues and of any particular
costs. product.

Absorption Variable
Costing Costing
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 Variable versus
Absorption Costing
Depreciation,
taxes, insurance and These are capacity
salaries are just as costs and will be
essential to products incurred even if nothing
as variable costs. is produced.

Absorption Variable
Costing Costing
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