Direct costing

Variable costing and segment reporting;

.Tolls of management
 Group member
•Zaid ail : 04152114080 ,

• Slide 1………13

• ,,

• Muhammad Aizaz khan : 04152114008

• Slide 13…to 23

• Jawad Ahmad. 04152014056

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 Direct costing
• Direct costing is a specialized
form of costing analysis that
only uses variable costing to
make decisions.

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 Learning objective 1

• Explain how variable costing differs from

absorption costing and compute unit
product costs under each method.

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 Three sampling assumption

• This chapter uses actual costing rather than the normal

costing approach that was used in the job-order costing
chapters.
• This chapter always uses the actual number of units
produced as the allocation base for assigning actual
fixed manufacturing overhead costs to products.
• This chapter always assumes that the variable
manufacturing costs per unit and the total fixed
manufacturing overhead cost per period remain
constant.

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 Overview of variable and absorption costing.

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 Variable costing

• Variable Costing Under variable costing, only those

manufacturing costs that vary with output are treated as
product costs. This would usually include direct
materials, direct labor, and the variable portion of
manufacturing overhead
• Common examples of variable costs include costs of
goods sold (COGS), raw materials and inputs to
production, packaging, wages, and commissions, and
certain utilities (for example, electricity or gas that
increases with production capacity).

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 Common example of variable costing

• Common examples of variable costs

include costs of goods sold (COGS), raw
materials and inputs to production,
packaging, wages, and commissions, and
certain utilities (for example, electricity
or gas that increases with production
capacity).

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 Unit cost computation of variable
costing part 1
• Harvey company produces a single product with the
following information available.

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 Unit cost computation part 2

• Unit product cost is determined as follow.

Under absorption costing, all production cost, variable

and fixed are included when determining unit product.
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•Income statement
of variable costing

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 Income statement format
• January February march
• Sales………………..
• .Variable expenses………………
• :Variable cost of goods sold…………
• .Variable selling and administrative ……
• expense…
• .Total variable expenses………..
• Contribution margin .....
• Fixed expenses:…………..
• Fixed manufacturing overhead ......
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 Absorption costing

• Absorption costing treats all manufacturing costs as

product costs, regardless of whether they are
variable or fixed. The cost of a unit of product
under the absorption costing method consists of
direct materials, direct labor, and both variable and
fixed manufacturing overhead.

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 Importants Points
• Absorption costing differs from variable costing because it allocates fixed overhead
costs to each unit of a product produced in the period
• .Absorption costing allocates fixed overhead costs to a product whether it was sold
in the period.
• This type of costing method means that more cost is included in the ending
inventory, which is carried over into the next period as an asset on the balance
sheet.
• Because more expenses are included in ending inventory, expenses on the income
statement are lower when using absorption costing.

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 Components of absorption
costing

• Absorption cost = (Direct labor costs +

Direct material costs + Variable
manufacturing overhead costs + Fixed
manufacturing overhead) / Number of units
produced.

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 Absorption costing unit product
cost
• Direct materials............................................................
• Direct labor.....................................................................
• Variable manufacturing overhead…………………..
• fixed manufacturing overhead………………………..
• Unit product cost…………………………………………………….

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Absorption costing income statement
• Sales……………………………………………………….
• Cost of goods sold ………………………………..
• Gross margin...............................................,…….
• .Selling and administrative expenses……………….
• Net operating income (loss). ...........................

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 Variable Costing vs Absorption Costing

• Absorption costing and variable costing are two different methods of costing
that are used to calculate the cost of a product or service. While both methods
are used to calculate the cost of a product, they differ in the types of costs that
are included and the purposes for which they are used. The differences
between absorption costing and variable costing lie in how fixed overhead
costs are treated.

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• Under absorption costing, all manufacturing costs, both
direct and indirect, are included in the cost of a product.
This means that the cost of each unit of a product
includes not only the direct costs of producing that unit,
such as raw materials and labor, but also a portion of
the indirect costs that were incurred in the production
process, such as overhead expenses. Absorption costing
is typically used for external reporting purposes, such
as calculating the cost of goods sold for financial
statements.

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• Variable costing, on the other hand, only includes direct
costs in the cost of a product. Indirect costs, or overhead
expenses, are not included in the cost of the product
under variable costing. Instead, they are treated as a
period expense and are recorded in the income statement
in the period in which they are incurred. Variable costing
is typically used for management decision-making and
planning purposes, as it provides a more accurate
representation of the incremental costs associated with
producing an additional unit of a product.

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• Variable costing does not determine a per-unit cost of
fixed overheads, while absorption costing does.
Variable costing will yield one lump-sum expense line
item for fixed overhead costs when calculating net
income on the income statement. Absorption costing
will result in two categories of fixed overhead costs:
those attributable to the cost of goods sold, and those
attributable to inventory.

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•Thank you

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