VARIABLE AND ABSORPTION

COSTING
PRODUCT COSTING
ABSORPTION COSTING – costing method that includes all
manufacturing costs (DM, DL and FOH) in the cost of a unit of product.
It treats fixed manufacturing overhead as a product cost. Also called
full costing, conventional costing.

VARIABLE COSTING – costing method that includes only variable

manufacturing costs (DM, DL and variable FOH) in the cost of a unit of
product. It treats fixed manufacturing overhead as a period cost. Also
called direct costing.
PERIOD COSTS VS PRODUCT COSTS
PERIOD COST PRODUCT COST
1. Refers to an item charged against current revenue 1. Refers to an item included in product costing which
on the basis of time period regardless of the is apportioned between sold and unsold units
difference between production and sales volume
2. Does not form part of the cost of inventory 2. The portion of the cost, which has been allocated
to the unsold units, becomes part of the inventory.
3. Diminishes income for the current period by its full 3. Diminishes income by that portion thereof
amount identified with the sold units only, with the remainder
being deferred to the next accounting period as part
of the cost of ending inventory.
Absorption Costing VS Variable Costing
Absorption Costing Variable Costing
1. Cost segregation Seldom segregate costs into variable and Costs are segregated into variable
fixed costs and fixed
2. Cost of inventory Cost of inventory includes all the Costs of inventory includes only the
manufacturing costs: materials, labor, variable manufacturing costs:
variable and fixed factory overhead materials, labor and variable
factory overhead
3. Treatment of fixed FOH Fixed factory overhead is treated as a Fixed factory overhead is treated as
product cost a period cost
4. Income statement Distinguishes between production and other Distinguishes between variable and
costs fixed costs
5. Net income Net income between the two methods may differ from each other because of the
difference in the amount of fixed overhead costs recognized as expense during the
accounting period. This is due to variations between sales and production. In the
long run, however, both methods give substantially the same results since sales
cannot continuously exceed production, nor production can continually exceed
sales.
 Costs Absorption Costing Variable Costing
Direct materials Product cost Product cost
Direct labor Product cost Product cost
Variable factory overhead Product cost Product cost
Fixed factory overhead Product cost Period cost
Variable selling expenses Period cost Period cost
Fixed selling expenses Period cost Period cost
Variable general and admin exp Period cost Period cost
Fixed general and admin exp Period cost Period cost
Net Income between AC and VC
Case AC Net Income VS VC Net Income
1. Production = Sales AC Net Income = VC Net Income
When production is equal to sales, there is no change in inventory. Fixed overhead expensed under the AC
equals fixed overhead expensed under VC.
2. Production > Sales AC Net Income > VC Net Income
When production is greater than sales, there is an increase in inventory. Fixed overhead expensed under AC
is less than fixed overhead expensed under VC.
3. Production < Sales AC Net Income < VC Net Income
When production is less than sales, there is a decrease in inventory. Fixed overhead expensed under AC is
greater than fixed overhead expensed under VC.
Arguments For the Use of Variable Costing
• Variable costing reports are simpler and more understandable
• Data needed for break-even and cost-volume-profit analyses are
readily available
• The problems involved in allocating fixed costs are eliminated
• Variable costing is more compatible with the standard cost accounting
system
• Variable costing reports provide useful information for pricing
decisions and other decision-making problems encountered by
management.
Arguments Against Variable Costing
• Segregation of costs into fixed and variable might be difficult,
particularly in the case of mixed costs
• The matching principle is violated by using variable costing which
excludes fixed overhead from product costs and charges the same
period costs regardless of production and sales.
• With variable costing, inventory costs and other related accounts,
such as working capital, current ratio, and quick ratio are understated
because of the exclusion of fixed overhead in the computation of
product cost.
AC vs VC illustration 1
BB Co. has the following data for the year 2022:

Units produced and sold 10,000

Selling Price per unit P100
Direct materials cost per unit P30
Direct labor cost per unit P20
Variable Overhead cost per unit P10
Fixed Overhead cost per unit P15
Variable selling expense per unit P2
Fixed selling expense per unit P1
Variable general and admin exp per unit P3
Fixed general and admin exp per unit P4
 AC VC
Sales (10,000 x P100) P1,000,000 P1,000,000
Less: Cost of Sales
Direct materials (10,000 x 30) 300,000 300,000
Direct labor (10,000 x 20) 200,000 200,000
Variable OH (10,000 x 10) 100,000 100,000
Fixed OH (10,000 x 15) 150,000
Cost of Sales 750,000 600,000
Gross Profit P250,000 P400,000
Less: Operating Expenses
Variable Selling (10,000 x 2) 20,000 20,000
Fixed Selling (10,000 x 1) 10,000 10,000
Variable G and A (10,000 x 3) 30,000 30,000
Fixed G and A (10,000 x 4) 40,000 40,000
Fixed OH (10,000 x 15) 150,000
Total Operating Expense 100,000 250,000
Net income P150,000 P150,000
AC vs VC illustration 2
BB Co. has the following data for the year 2022:

Units produced 10,000

Units sold 8,000
Selling Price per unit P100
Direct materials cost per unit P30
Direct labor cost per unit P20
Variable Overhead cost per unit P10
Fixed Overhead cost per unit P15
Variable selling expense per unit P2
Fixed selling expense per unit P1
Variable general and admin exp per unit P3
Fixed general and admin exp per unit P4
 AC VC
Sales (8,000 x P100) P800,000 P800,000
Less: Cost of Sales
Direct materials (10,000 x 30) 300,000 300,000
Direct labor (10,000 x 20) 200,000 200,000
Variable OH (10,000 x 10) 100,000 100,000
Fixed OH (10,000 x 15) 150,000
Less: Ending Inventory (2,000 x 75 or 60) (150,000) (120,000)
Cost of Sales 600,000 480,000
Gross Profit P200,000 P320,000
Less: Operating Expenses
Variable Selling (8,000 x 2) 16,000 16,000
Fixed Selling (8,000 x 1) 8,000 8,000
Variable G and A (10,000 x 3) 30,000 30,000
Fixed G and A (10,000 x 4) 40,000 40,000
Fixed OH (10,000 x 15) 150,000
Total Operating Expense 94,000 244,000
Net income P106,000 P76,000
AC vs VC illustration 3
BB Co. has the following data for the year 2022:
Units produced 8,000
Units sold 10,000
Beginning inventory units 2,000
Selling Price per unit P100
Direct materials cost per unit P30
Direct labor cost per unit P20
Variable Overhead cost per unit P10
Fixed Overhead cost per unit P15
Variable selling expense per unit P2
Fixed selling expense per unit P1
Variable general and admin exp per unit P3
Fixed general and admin exp per unit P4
 AC VC
Sales (10,000 x P100) P1,000,000 P1,000,000
Less: Cost of Sales
Beginning inventory ( 2,000 x 75 or 60) 150,000 120,000
Add: Direct materials (8,000 x 30) 240,000 240,000
Direct labor (8,000 x 20) 160,000 160,000
Variable OH (8,000 x 10) 80,000 80,000
Fixed OH (8,000 x 15) 120,000
Cost of Sales 750,000 600,000
Gross Profit P250,000 P400,000
Less: Operating Expenses
Variable Selling (10,000 x 2) 20,000 20,000
Fixed Selling (10,000 x 1) 10,000 10,000
Variable G and A (10,000 x 3) 30,000 30,000
Fixed G and A (10,000 x 4) 40,000 40,000
Fixed OH (8,000 x 15) 120,000
Total Operating Expense 100,000 220,000
Net income P150,000 P180,000
Reconciliation of Operating Income Between
AC and VC
Formula
Operating Income, AC Pxxx
Add: Fixed Overhead in Ending Inventory Xxx
Less: Fixed Overhead in Beginning Inventory Xxx
Operating Income, VC Pxxx
OR
Operating Income, VC Pxxx
Add: Fixed Overhead, Beginning Inventory Xxx
Less: Fixed Overhead, Ending Inventory Xxx
Operating Income, AC Pxxx
Application (based on Illustration 2)

Operating Income, AC P106,000

Add: Fixed Overhead in Beginning Inventory
Less: Fixed Overhead in Ending Inventory (2,000 x 15) (30,000)
Operating Income, VC P76,000
OR
Operating Income, VC P76,000
Add: Fixed Overhead, Ending Inventory under AC 30,000
Less: Fixed Overhead, Beginning Inventory under AC
Operating Income, AC P106,000
Application (based on Illustration 3)

Operating Income, AC P150,000

Add: Fixed Overhead in Beginning Inventory 30,000
Less: Fixed Overhead in Ending Inventory (2,000 x 15)
Operating Income, VC P180,000
OR
Operating Income, VC P180,000
Add: Fixed Overhead, Ending Inventory under AC
Less: Fixed Overhead, Beginning Inventory under AC (30,000)
Operating Income, AC P150,000
Exercise 1
TT Co. has the following data pertaining to its only product:
Units sold 15,000
Units produced 14,000
Beginning inventory units 1,000
Selling price P40 per unit
Variable costs Fixed Costs
Direct material, P5 per unit Overhead, P2.50 per unit
Direct labor, P4 per unit General and admin exp, P40,000
Overhead, P2 per unit
Selling expenses P3 per unit
Exercise 1
Required:

1. Determine the gross profit under AC and VC

2. Determine the product cost under AC and VC
3. Determine the operating income under AC and VC
4. Reconcile the operating income between AC and VC
Exercise 2
VV Co. has the following data pertaining to its only product:
Units sold 20,000
Units produced 25,000

Selling price P50 per unit

Variable costs Fixed Costs
Direct material, P3 per unit Overhead, P1.50 per unit
Direct labor, P2 per unit General and admin exp, P100,000
Overhead, P10 per unit
Selling expenses P1 per unit
Exercise 2
Required:

1. Determine the gross profit under AC and VC

2. Determine the product cost under AC and VC
3. Determine the operating income under AC and VC
4. Determine the cost of ending inventory under AC and VC
5. Reconcile the operating income between AC and VC