Managerial Accounting Absorption and Variable Costing 081712

VARIABLE COSTING ARLAN C. FAJARDO

JOSEPH

Basic principles



Variable costing is the same as marginal costing, direct costing, or contribution margin costing. 



Variable costing is an extension of CVP analysis.

The basic assumptions in the marginal costing (i.e., CVP analysis) are followed except that production is not equal to sales. 

Technically speaking, variable costing and direct costing are different. Variable costing includes -variable production costs as part of the product cost while direct costing includes all costs directly identified with the segment as product costs- Another, variable costing focuses on the contribution margin while direct costing zeroes-in on segment margin. 

The unit costs from the preceding period are the same in the current period; meaning, unit costs are assumed to be constant 

Treatment of fixed overhead, and other costs and expenses



 Under

absorption costing, fixed overhead is a product cost, inventoriable costs, or deferrable costs. This means theft the cost assigned to- the product is charged against sales when the units are sold, and is still deferred in the inventory when the units are still unsold. This follows toe principle of matching of costs against revenues.

 Under variable costing, fixed overhead is a period cost, meaning,

outright an expense. This means the fixed overhead is immediately charged against revenues without regard as to whether the units are already sold or stiff unsold. This follows the immediate recognition principle. The rationale for this treatment is because the fixed overhead would be incurred regardless of whether the production occurs or not, and therefore, should not be treated as product cost.

 Direct materials, direct labor, and variable overhead -are product

costs, both to absorption and variable costing systems.

 Variable expenses and fixed expenses are period costs> both to

absorption and variable costing-systems. Computation guidelines



Computation of unit costs: AC

VC

Px

Px

Unit variable production costs (i.e., direct materials, direct labor, and variable factory overhead) Unit fixed ovefhead (Budgeted fixed OH / Normal

x

ni

capacity) Unit costs (where: ni = nonincluded) PAGE 1 OF 27

Px

Px

 Computation of operating income AC Sales Variable CGS Fixed OH

VC

QS x USP Px

Px

QS x UVC (x)

(x)

QS x UFC (x)

Variable expenses Fixed expenses

(x)

QS x UVE (x) NC x UFE

Operating income

[NC x UFC]

(x)

(x)

(x)

P x

P x

where: NC = normal capacity QS

= quantity sold

UFC = unit fixed costs UVE = unit variable expense

USP = unit sales price UFE = unit fixed expense UVC = unit variable costs  Cost of ending inventory = Ending inventory in units x Unit cost  Reconciliation of operating income under absorption and variable costing systems (using three models):  Production model Production Sales Change in inventory

x x x (also Beg. invty -Ending invty)

x Unit fixed costs

P x

 Change in operating  Inventory model Beginning inventory AC VC Ending inventory AC VC Change in operating income  Costs model Fixed overhead charged Px

P x

Px P x X x X x X x

Px

x Px

under AC (QS x UFxC)

Fixed overhead charged under VC (NC x UFxC) _x Px

Change in operating income [(QS - NC) x UFxC]  Treatment of costs variances and computation of volume variances



Costs variances are treated as follows: PAGE 2 OF 27

UF costs variances are added to CGS at standard or deducted from operating income. 

Favorable costs variances are deducted from CGS at standard or added to operating income. 

Volume variance is included only in the absorption costing operating income. 

 Computation of operating income with costs variances: AC VC Px Px (x) (x) (x) (x)

Sales QS x USP Variable CGS QS x UVC Fixed OH QS x UFC Variable production costs variances - UF (x) (x) - F x x Volume variance - (UF) F x ni Fixed expenses NC x UFE (x) Operating income Px (where: ni = not included)

 Volume variance = ? Normal capacity in units x - Actual capacity in units __ x Volume variance in units - under(over) absorbed x Unit fixed costs Px Volume variance in pesos

[NC x UFC]

(x) Px

x UF (F) P x UF (F)

 Sales and variable costing, production and absorption costing

(Which follows which?)

 Variable costing income follows sales; that is: If VC Operating Income VC Operating Income is Sales > Production Increases Greater than AC Sales < Production Decreases Lower than AC  Absorption costing income follows production; that is: If AC Operating Income AC Operating Income is Production > Sales increases Greater than VC Production < SalesDecreases Lower than VC STRAIGHT PROBLEMS 1. Operating income, inventoriable costs, and costs of ending inventory. Golden Company produces an inexpensive product that sells for P160. Selected data for the company's operations last year follow: Units in beginning inventory Normal capacity Variable costs per unit: Direct materials Direct labor Manufacturing overhead Selling and administrative Fixed costs per unit: Manufacturing overhead

4,000 50,000

PAGE 3 OF 27

P 25 40 45 10 20

Selling and administrative

15

The fixed selling and administrative expenses are also based on normal capacity.

Required: a. Determine the operating income under absorption and variable costing methods assuming the following independent cases; Production Sales Production Sales a. 50,000 53,000 d. 54,000 35,000 b. 50,000 48,500 e. 48,000 51,500 c. 50,000 50,000 b. Account for the difference in operating income under the absorption costing method and variable costing method. 2. Income statements with variances. MELANIE Company produces and sells a unique it has just opened a new plant to manufacture the antenna, and the following costs and revenue data are reported for the second month of the company's operations. The management is anxious to see how profitable the new antenna will be and has asked that an income statement be immediately prepared for the month using the following data.

Beginning inventory 200

Units produced 4,400

Normal capacity

4,000

Units sold

4,300

Sales price per unit P 500 Selling and administrative expenses: Variable per unit sales

5% of

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Fixed P160,000 Manufacturing costs: Direct materials cost per unit 80 Direct labor cost per unit 170 Variable overhead cost per unit 20 Fixed overhead cost (total) P340,000 Production cost variances: Direct materials variances, net 30,000 UF Direct labor variances, net 7,500 F Variable OH controllable variance 22,00 UF Required: For the second month: a.

Compute the volume variance.

b. Compute the operating income under absorption and direct costing methods for the second month. c.Determine the cost of ending inventories under the absorption costing and direct costing. d. Reconcile the difference in operating income under absorption and direct costing methods. Determine which costing method results to a higher income.

MULTIPLE CHOICE Basic Concepts 1. Under the direct costing, which is classified as product costs? A. Only variable production costs. B. Only direct costs. C. All variable costs. D. Ail variable and fixed production costs. 2. In absorption costing, as contrasted with direct costing, the following are absorbed into inventory. A. All the elements of fixed and variable manufacturing overhead. B. Only the fixed manufacturing overhead. C. Only the variable manufacturing overhead. D. Neither fixed nor variable manufacturing overhead. 3. The absorption costing method includes in inventory PAGE 5 OF 27

Fixed factory overhead A. B. C. D.

No No Yes Yes

Variable factory

overhea d No Yes Yes No

4. in an income statement prepared as an internal report using the direct (variable) costing method, fixed selling and administrative expenses would A. Not be used. B. Be used in the computation of the contribution margin. C. Be used in the computation of operating income but not in the computation of the contribution margin. D. Be treated the same as variable selling and administrative expense 5. In an income statement prepared as internal report using the variable costing method, variable selling and administrative expense would A. Not be used. B. Be used in the computation of the contribution margin. C. Be used in the computation of operating income but not in the computation of the contribution margin. D. Be treated the same as fixed selling and administrative expenses. 6. A type of managerial accounting which refers to the determination of he operating cost regardless of cost behavior, whether variable or non-variable, is A. Differential accounting. C. Responsibility accounting. B. Full cost accounting. D. Profitability accounting. 7. When all manufacturing costs used in production are attached to the products, whether direct, or indirect, variable of fixed, this is called: A. Process costing C. Variable costing B. Absorption costing D. Job Order costing 8. For a multiple- product company, in determining the break-even point, which of the following assumptions are commonly used when variable costing is adopted? I. Sales equal production. II. Unit variable cost is constant. III. Sales mix is constant. A. I and III B. I and II C. I, II and lII D. II and III 9. Care Company's 2006 fixed manufacturing overhead cost totaled P100,000 and variable PAGE 6 OF 27

selling costs totaled P80,000. Under direct costing, how should these costs be classified? Period Cost

Product Cost

A.

P

0

P 180,000

B.

P 80,000

P 100,000

C.

P100,000

P 80,000

D.

P180,000

P

0

10. If production is greater than sales (units), then absorption costing net income will generally be A. Greater than direct costing net income. B. Less than direct costing net income. C. Equal to direct costing net income. D. Additional data is needed to be able to answer. 11. Which of the following statements is correct? A. When production is higher than sales, absorption costing net income is lower than variable casting net income. B. If all the products manufactured during the period are sold in that period, variable costing net income is equal to absorption costing net income. C. When production is lower than sates, variable costing net income is lower than absorption costing net income. D. When production and sales level are equal, variable costing net income is lower than absorption costing net income. 12. Operating income using direct costing as compared to absorption costing would be higher A. When the quantity of beginning inventory equals the quantity of ending inventory. B. When the quantity of beginning inventory is more than the quantity of ending inventory. C. When the quantity of beginning inventory is less than the quantity of ending inventory. D. Under no circumstances. 13. If sales equal production, one would expect net income under the variable costing method to be A. The same as net income under the absorption costing method. B. Greater than net income under the absorption costing method.

PAGE 7 OF 27

C. Differing in as much as the difference between sales and production. D. Less than net income under the absorption costing method. 14. Determine the following statements as true or false. Statement 1. Direct costing and variable costing are different terms that mean the same thing. Statement 2. In a variable costing income statement, sales revenue is typically lower than in absorption costing income statementStatement 1 Statement 2 A. False True B. False False C. True True D. True False 15. If sales exceed production, one would expect net income under the variable costing method to be A. The same as net income under the absorption costing method. B. Greater than net income under the absorption costing method. C. Differing in as much as the difference between sales and production. D. Less than net income under the absorption costing method. 16. Other things being equal, income computed by the direct costing method will exceed that computed by an absorption costing method if A. Fixed manufacturing cost increases. B. Units sold exceed units produced. C. Variable manufacturing costs increase. D. Units produced exceed units sold 17. President X of WXY Corporation requested you to explain the different in net income between the variable costing income statement presentation and the absorption method. You would say that the difference: A. Is none if there is no change in the fixed costs in the beginning and ending inventories. B. Is equal to the fixed cost per unit times the number of units sold. C. Is attributable to the variable costs in the inventory. D. Is attributable to the fixed cost in ending inventory. 18. Identify the following statements as true or false. Statement 1. included as

In a variable costing system, fixed overhead costs are

cost of inventory. Statement 2. discloses

Under the direct costing method, the contribution margin

the excess of revenues over fixed costs. A. Statement 1 is true, Statement 2 is true. B. Statement 1 is true, Statement 2 is false. C. Statement 1 is false, Statement 2 is true. PAGE 8 OF 27

D. Statement 1 is false, Statement 2 is false. 19.

Identify the following statements as true or false.

Statement 1. inventory

In direct costing, fixed factory overhead forms part of the

value. Statement 2. The difference in net income between variable costing and absorption costing is due entirely to the treatment of fixed manufacturing overhead. A. Statement 1 is true, Statement 2 is true. B. Statement 1 is true, Statement 2 is false. C. Statement 1 is false, Statement 2 is true. D. Statement 1 is false, Statement 2 is false. Inventoriable costs 20. Excellent Writer produces and sell boxes of signing pens for P1,000 per box. Direct materials are P400 per box and direct manufacturing labor averages P75 per box. Variable overhead is P25 per box and fixed overhead is P12,500,000 per year. Administrative expenses, all fixed, run P4,500,000 per year, with sales commissions of P100 per box. Production is expected to be 100,000 boxes, which is met every year. For the year just ended, 75,000 boxes were sold. What is the inventoriable cost, per box using variable costing? A. P770

C. P475

B. P500

D. P625

21. For P1,000 per box, the Majestic Producers, Inc., produces and sell delicacies. Direct materials are P400 per box and direct manufacturing labor averages P75 per box. Variable overhead is P25 per box and fixed overhead is P12,500,000 per year. Administrative expenses, all fixed, run P4,500,000 per year, with sales commissions of Pi 00 per box. Production is expected to be 100,000 boxes, which is met every year. For the year just ended, 75,000 boxes were sold. What is the inventoriabie costs per box using absorption costing. A. P625

C. P770

B. P500

D. P670

22. Compute for the inventory value under the direct costing method using the data given: units unsold a the end of the period, 45,000; raw materials used, P6.00 per unit; raw materials inventory, beginning, P5.90 per unit; direct labor, P3.00 per unit; variable overhead per unit, P2.00 per unit; indirect labor for the month, P33.750. Total fixed costs, P67.500. A. P 16.90 C. P 17.45 B. P 11.00

D. P 19.15

23. With a production of 200,000 units of product A during the month of June, Bucayao Corporation has incurred costs as follows: PAGE 9 OF 27

Direct materials Direct labor used Manufacturing overhead: Variable Fixed Selling and administrative expense Variable Fixed Total

P 200,000 135,000 75,000 90,000 30,000 85.000 P615.000

Under absorption costing, the unit cost of product A was: A. P2.20 C. P3.25 B. P2.50 D. P2.05 Questions 24 and 25 are based on the following data: Una Company produced 100,000 units of Product Zee during the month of June. Costs incurred during June were as follows: Direct materials

P 100,000

Direct labor

80,000

Variable manufacturing overhead Fixed manufacturing overhead

40,000 50,000

Variable selling and general expenses

12,000

Fixed selling and genera! expenses

46,000

Total

P327,000

24. What was product Zee's unit cost under absorption costing? A. P3.27 C. P2.32 B. 25.

P2.70

D. P1.80

What was product Zee's unit cost under variable (direct) costing?

A. P2.82 B. P2.70

C. P2.32 D. P2.20

Operating income 26. LY & Company completed its first year of operations during which time the following information were generated: Total units produced Total units sold Work in process Cost: Fixed cost: Factory overhead Selling and Per unit variable cost Raw materials Direct labor Factory overhead Selling and

100,000 80,000 @P100/un]t none P1.2 million P0.7 million P 20.00 12.50 7,50 10.00

If the company used the variable (direct) costing method, the operating income would be A. P2.100.000 C. P2,480,000 PAGE 10 OF 27

B. P4,000,000

D. P3,040,000

27. Gordon Company began its operations on January 1, 2006, and produces a single product that sells for P10 per unit. Gordon uses an actual (historical) cost system, in 2006, 100,000 units were produced and 80,000 units were sold. There was no workin-process inventory at December 31, 2006. Manufacturing costs and selling and administrative expenses for 2006 were as follows: Fixed costs

Variable costs

Raw materials

-

P2.00/unit produced

Direct labor

-

P1.25/unit produced

Factory overhead

P 120,000

Selling and administrative

P 70,000

P0.75/unit produced P1.00/unit produced

What would be Gordon's operating income for 2006 under the variable (direct) costing method? A. P114,000 B.

P210,000

C P234,000 D. P330.000

28. If net earnings were higher using standard direct costing than using standard absorption costing, what can be said about sales during the period if inventory is priced using the LIFO method? A. Sales increased. C. Sales decreased. B. Sales exceed production.

D. Sales were less than production.

Questions 29 and 30 are based on the following information. Expected to operate at normal capacity, Golden Corporation plans to manufacture 275,000 units of products in 2006, and the following estimates with respect to sales: Sales in units

250,000

Unit selling price

P 35.00

Finished goods inventory on December 31, 2005 is estimated at. 25,000 units costing P500,000. Included in this amount is the fixed manufacturing overhead amounting to P300.000. No changes in both the fixed manufacturing cost and the variable cost per unit of produce are expected in 2006. 29. What is the estimated income from manufacturing using the absorption costing method? A. P 3,750,000 C P 3,550,000 B. P 3,450,000 D. P 3,750,000 30. What is the estimated income from manufacturing using the variable costing method? A. P 3,150,000 C. P 3,450,000 PAGE 11 OF 27

B. P 3,550,000

D. P 3,750,000

31. Taba Ching Ching Biscuits manufactures and sells boxed coconut cookies. The biggest market for these cookies are as gift that college students buy for their business teachers. There are 100 cookies per box. The following income statement shows the results of the first year of operations. This statement was the one included in the company's annual report to the stockholders. Sales (400 boxes at P12.50) P 5,000.00 Less: Cost of goods sold (400 boxes at P12,50) 3.200.00 Gross margin 1,800.00 Less: Selling and administrative expenses 800.00 Net income P 1,000.00 Variable selling and administrative expenses are P0.90 per box unit. The company, produced 500 boxes during the year. Variable manufacturing costs are P5.2$ per box and fixed manufacturing overhead costs total P1.375 for the year. What Is the company's direct costing net income? A. P 2,540 C. P 1,000 B. P 2,265

D. P 725

32. Dotdot, Ltd., manufactures a single product for which the costs and selling prices are: Variable production costs P 50/unit Selling price P 150 / unit Fixed production overhead P 200,000 / quarter Fixed selling and administrative overhead P 480,000 / quarter Normal capacity is 20,000 units per quarter Production in 1 quarter was 19,000 units and sales volume was 16,000 units No opening inventory for the quarter. The absorption costing profit for the quarter was: A. P920,000 C. P960.000 B. P950,000 Fixed expenses Net income

D. P970.000 ( 480.000)

Questions 33 and 34 are based on the following information. The following operating data are available from the records of Sheena Company for the month of January 2005: Sales (P 70 per unit) P 210,000 Direct materials 59,200 Direct labor 48,000 Manufacturing overhead: Fixed 36,080 Variable 24,000 PAGE 12 OF 27

Marketing and general expenses: Fixed 11,000 Variable 5% of sales Production in units - 3,280 units Beginning inventory- none 33. The ending finished goods inventory under absorption costing method would be A. P14.280 C P12,096 B. P16.968 D. P16.072 34. The net income for the month under the variable costing method would be A. P32,420 C P23,320 B. P25,500 D. P22,420 Questions 35 through 38 are based on the following information. Sales per unit P 15.00 Variable production cost 8.00 Annual fixed production 35,000.00 Variable office expense 3.00 Annual fixed selling 15,000.00 Produced 12,500 units during the period No inventory at January 1 Sold 10,000 units 35. The ending inventory under direct costing is A. P25,000 B. P27,500 36.

C P20,000 D. P32,500

Ending inventory under absorption costing is

A. P32,500

C. P25.000

B. P20.000

D. P27.000

37.

Total variable annual cost charged to expense in direct costing

A. P110,000

C. P80.000

B. P117,500

D. P100,000

38. Total fixed cost charged against current year's operations in absorption costing. A. P35,000 B. P25,000

C P15,000 D. P43,000

Reconciliation of income Questions 39 and 41 are based on the following information. The books of Mariposa Company pertaining to the year ended December 31, 2006 operations, showed the following figures relating to product A:

PAGE 13 OF 27

Beginning inventory-finished goods and work in process none No. of units produced 40,000 units No. of units sold at P15 32r500 units Direct materials used P 177,500 Direct labor used P 85,000 Manufacturing costs: Fixed P 110,000 Variable 61,500 P 171,500 Fixed administrative expenses P 30,000 39. Under variable costing, what would be the finished goods inventory as at December 31,2006? A. P 81,375.00 C. P 87,000.00 B. P 60,750.00 D. P 49,218.75 40. Which costing method, variable or absorption costing, would show a higher operating income for 2006 and by how much? A. Variable by P20.625 C. Variable by P26,250 B. Absorption by P20,625 D. Absorption by P26,250 41. During the year 2006, Catara Corporation manufactured 70,000 units of product A, a new product. Only 65,000 units were sold during the year. There was no beginning inventory. Manufacturing cost per unit was P20.00 variable and P50.00 fixed. What would be the effect on net income if absorption costing is used instead of variable costing? A. Net income is P250,000 lower B. Net income is P250,000 higher C. Net income is P100,Q0p lower D. Net income is P100,000 higher 42. At the end of Kiko Company's first year operations, 1,000 units of inventory remained on hand. Variable and fixed manufacturing cost per unit were P90 and P20, respectively, if Kiko uses absorption costing rather than direct (variable) costing, the result would be a higher pretax income of A. P20,000 C. P 0 B. P70,000 D. P90,000 Income with variances 43. The production volume variance occurs when using A. The absorption costing approach because of production exceeding the sales. B. The absorption costing approach because production differs from that use in setting the fixed overhead rate used in applying fixed overhead to production. C. The variable costing approach because of sales exceeding the production for the period, PAGE 14 OF 27

D. The variable costing approach because of production exceeding the sales for the period. 44.

Sta. Maria Inc. reported the following data for 2006: Actual hours 120,000 Denominator hours 150,000 Standards hours allowed for output 140,000 Fixed predetermined overhead rate P6 per hour Variable predetermined overhead rate P4 per hour

Sta. Maria's 2006 volume variance was: a. P60,000 which is neither favorable nor underapplied. b. P60.000 favorable. c. No volume variance. d. P60,000 underapplied

-E N D-

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