Distinction between production and period cost

Product costs are those directly associated with the production of a for-sale product or
service. Period costs include all other indirect costs incurred during production.

Inventory costs between variable and absorption costing

Fixed overhead costs are allocated across all units produced over time using absorption costing.
Variable costing, on the other hand, adds up all fixed overhead costs and reports the expense as a
separate line item from the cost of goods sold or still available for sale.

Variable costing is a methodology that only assigns variable

costs to inventory. This approach means that all overhead costs
are charged to expense in the period incurred, while direct
materials and variable overhead costs are assigned to
inventory. Absorption costing allocates fixed overhead costs to
a product whether or not it was sold in the period.
Nature and treatment of fixed factory overhead costs

Fixed manufacturing overhead costs are recognized as period costs in variable costing and are thus
always expensed in the period incurred. Fixed manufacturing overhead costs are included as an indirect
cost in the cost of a product under absorption costing.

Reconciliation of operating income under variable costing and absorption costing

When fixed manufacturing overhead costs are deferred in inventory, they are added to the variable
costing income figure, and when they are released from inventory, they are removed from the variable
costing income figure. By (a) deducting the manufacturing overheads carried forward (absorbed by
shutting inventories) and (b) adding the manufacturing overheads brought in, net income under
absorption costing can be reconciled with net income under variable costing (absorbed by opening
inventories).

- 5. When reconciling variable costing and absorption costing net operating income, fixed
manufacturing overhead costs deferred in inventory under absorption costing should be
added to variable costing net operating income to arrive at the absorption costing net
operating income.

MY OWN INSIGHTS

Unit product cost will be higher under absorption costing because it includes fixed manufacturing
overhead