Variable Costing—A Tool for Management Show
Learning Objectives
Chapter Overview A. Overview of Variable and Absorption Costing. At least two methods can be used in manufacturing companies to value units of product for accounting purposes—absorption costing and variable costing. These methods differ only in how they treat fixed manufacturing overhead costs.
B. Comparison of Absorption and Variable Costing. When comparing absorption costing and variable costing income statements, a number of points should be noted:
C. Extended Comparison of Income Data. Exhibit 7-3 in the text presents a comparison of absorption costing and variable costing income statements over three years in which production is constant but sales vary. Exhibit 7-6 in the text also presents comparative income statements over three years but holds annual sales constant and varies annual production. From these Exhibits, several generalizations can be drawn. (All of these generalizations assume the LIFO inventory flow assumption is being used. The generalizations may not hold in some rare cases if a company uses an inventory flow assumption other than LIFO.)
D. The Matching Principle. Accountants and managers have been arguing for decades concerning the relative merits of absorption and variable costing. In practice, absorption costing is used far more than variable costing even for internal reports. The reasons for this are not entirely clear, although the perception that absorption costing is required for external reporting undoubtedly plays a key role. The argument for using absorption costing in external reports seems to be based on the matching principle.
E. Advantages of the Contribution Approach. There are a number of advantages to using variable costing (and the contribution approach) in internal reports and analysis.
F. Impact of JIT Inventory Methods. When companies use JIT methods for controlling their operations, the distortions of income that can occur under absorption costing largely (or completely) disappear.
When production is greater than sales absorption income is greater than variable costing income?When production is greater than sales, i.e. ending inventory is greater than the beginning inventory, the operating income under absorption costing is greater. 3. When production is less than sales, i.e. ending inventory is less than the beginning inventory, operating income under variable costing is greater.
What is the relationship between absorption costing net income and variable costing net income?When units produced are greater than units sold, i.e., units in inventory increase, absorption income is greater than variable costing income because absorption costing defers a portion of fixed manufacturing costs in finished goods inventory.
What happens when production is greater than sales?Explanation: If production exceeds sales, the profit under absorption costing is higher as compared to variable costing. This is due to the deferral of fixed manufacturing overhead costs to the next period in ending inventory, leading to reduced cost of goods sold for the current period and hence a higher profit.
In what instances would net income under variable costing exceed the net income under absorption costing?If sales are more than production, then net income under variable costing will exceed net income under absorption costing.
|