Variable and Absorption Costing

Variable and Absorption Costing

• Variable Costing and Absorption Costing are not systems of costing such as process,
operating m batch or job costing
• In Variable costing approach only variable costs are taken int account for the purposes

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Total Costs
• In absorption costing total costs are taken into account for those purposes .
• The variable costing is in marked contrast to the orthodox costing system known as full/
absorption/traditional costing
• Diff: in full costing it absorbs all the costs necessary to produce the product and have it in a
saleable form

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• Income statements for external reporting

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Variable and Absorption Costing
Variable Costing is employed under the assumption that a certain
investment in facilities and other productive factors.

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Income Statement (Variable Costing)
Amount
Sales Revenue
Less Variable Costs
Direct Mat Costs
Direct Labour Costs
Var Manuf O/H
Total Cost of Manuf
Plus Cost of Inventory in beg
Less Cost of Inventory in end
Cost of Manuf and Sold
Contribution
Less Fixed Costs
Fixed Prod Costs
Fixed Non Prod Costs
EBIAT
Less Taxes
Income Statement (Absorption Costing)
Sales Revenue

Less Variable Costs

Direct Mat Costs
Direct Labour Costs
Var Manuf O/H
Fixed Manuf O/H
Total Cost of Manuf
Plus Cost of Inventory in beg
Less Cost of Inventory in end
Cost of Manuf and Sold
Gross Margin (un)
Adjustment for Capacity Variance
Gross Margin (ad)
Less non production costs
S&Distri
• H inc furnishes the following info
• Normal Pr 1000
• Actual Pr 1100
• Actual O/H per quarter (at normal prod)
4000
• Other Expenses 300
• Standard F O/H rate p u 4
• Var cost per unit 6
• Sales Volume Nil
• H2 furnishes the following info for its three different periods
• Y1 Y2 Y3
• Prod 10000 10000 10000
• Sales 10000 5000 15000

• SP per unit 12
• VC per unit 6
• Fixed costs per year(at normal capacity) Rs 40000
• Standard fixed overhead rate Rs 4 per unit
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Over Applied or Under Applied
Manufacturing OVerheads
• When predetermined overhead rate is used as absorption of
absorption of overheads it is seldom that the total overhead costs
applied to jobs in a given period are equal to the total overhead cost
of a job
• Let us say the company’s overheads were Rs 1,80,000 and total direct
labour hours used were 45000 in the first quarter
• Overhead variances may be disposed of the following either of the
two they may be assigned to the income statement of the current
period by charging the entire amount to the cost of goods sold
account
Batch Costing
• Is a system of cost accumulation.
• It is a variant of job costing
Job-Costing System Example
Job-Order Costing, General Flow of Costs (in 000)
Learning Summary journal entries for
Objective 2
the a job-order costing system
Trace direct materials and direct labor costs to WIP.
Applying Factory Overhead Costs
Accountants trace actual direct materials
and direct labor costs to products, and apply
factory overhead costs to WIP via budgeted
(predetermined) overhead rates.

To charge actual overhead costs to

Factory Department Overhead:
Applying Factory Overhead Costs

To compute budgeted overhead rates, for each

department determine: 1) cost-allocation base,
2) budgeted overhead costs, and 3) budgeted
amount of each cost-allocation base.

Apply factory overhead costs to jobs:

Applying Factory Overhead Costs

Enriquez allocates overhead based on machine

hours in machining and direct-labor cost in
assembly, resulting in the following overhead
rates:
Applying Factory Overhead Costs

Applied overhead for 20X1 is $375,000

Summary journal entry:

Finished Goods, Sales, and Cost of Goods Sold

Transactions that recognize the completion of

production and the eventual sale of the goods.
Finished Goods, Sales, and Cost of Goods Sold

Assuming the use of the immediate write-off method

to dispose of under- or overapplied overhead:

The preceding seven transactions recorded direct

materials, direct labor, and factory overhead costs
incurred during 20X1. Costs flowed through WIP to
either Direct-Materials Inventory, WIP Inventory,
Finished-Goods Inventory, or Cost of Goods Sold.
 Learning Activity-Based Costing in a
Objective 3
Job-Costing Environment

ABC increases costing accuracy by focusing

On the cause-and-effect relations between:

Work Consumption
performed of resources
(activities) (costs)
ABC in a Job-Order Environment Illustration

Dell focuses on the most critical (core)

processes across the value chain, the
design and production processes.

Dell then added the remaining phases of

the value chain, the functions (or core
processes) that add value to the
company’s products.

Dell assigns the costs of these functions

to an individual job under the current ABC
system.
ABC in a Job-Order Environment Illustration
 Learning Product Costing in Service and
Objective 4
Nonprofit Organizations

Service and nonprofit organizations

call their “product” a program
or a class of service.

In service industries, each

customer order is a different job.
Budgets and Control of Engagements
Accounting Firm Condensed Budget

The budgeted total cost of an engagement is the

direct-labor cost plus applied overhead (260% of
direct-labor cost plus any other direct costs).
Accuracy of Costs of Engagements
Suppose that this accounting firm’s policy
for price quotes is 200% of total
professional costs plus travel costs.
Process Costing

The cost accounting system used

by a company depends upon the
nature of its products or services.

Process-costing systems apply costs to

homogeneous products that a company mass
produces in continuous fashion through a
series of production processes.
Learning
Process Costing Compared
Objective 5
With Job Costing

The journal entries for process-costing

systems are similar to those
for the job-order system.

However,

Job-costing has one WIP account.

Process costing requires one WIP
account for each processing department.
Process Costing Compared
With Job Costing
Process costing does not
distinguish among
individual units of product.

It accumulates costs for Process costing can

a period and divides be applied to non-
them by quantities produced manufacturing and
during the period to get manufacturing
broad, average unit costs. activities.