Chapter 9

Variable Costing
A Tool for Management
Variable Costing: A Tool for Management
• Overview of absorption and variable costing
• Income comparison of absorption and variable costing
• Extended comparison of absorption and variable costing
• Effect of changes in production on net operating income
• Choosing a costing method
Learning Objectives
• Explain how variable costing differ from absorption costing and
compute unit production cost under each method
• Prepare income statements using both variable and absorption
costing
• Reconcile variable costing and absorption coating net operating
incomes and explain why the two amounts differ
• Understand the advantages and disadvantages of both variable
and absorption costing
• 
Marginal and Absorption Costing (Concept)
• Absorption costing treats all manufacturing costs as product
costs, regardless of whether they are variable or fixed. The cost of a
unit of product under the absorption costing method consists of
direct materials, direct labor, and both variable and fixed
manufacturing overhead.

• Under variable costing , only those manufacturing costs that vary

with output are treated as product costs. This would usually
include direct materials, direct labor, and the variable portion of
manufacturing overhead.
Marginal and Absorption Costing (Concept)
• Selling and administrative expenses are never treated as product
costs, regardless of the costing method. Thus, under absorption
and variable costing, variable and fixed selling and administrative
expenses are always treated as period costs and are expensed as
incurred.
Scenario
Unit Cost Calculation
Unit Cost under Absorption Costing
Unit Cost under Variable Costing
Cost of Goods Sold
Variable Costing Cost of Goods Sold
Cost of Goods Sold (Absorption Costing)
Income Statement
Income Statement – Absorption Costing
Income Statement – Variable Costing
Reconciliation
Reason for Difference
• The differences between marginal and absorption costing occur
because under absorption costing some fixed manufacturing
overhead is capitalized in inventories (i.e., included in product
costs) rather than being immediately expensed on the income
statement.

• If inventories increase during a period, under absorption costing

some of the fixed manufacturing overhead of the current period
will be deferred in ending inventories.
Equation to find the differences
Differences Calculation

35k x 1
Reconciliation
Comparative Income Effect on Inventory
Movement
Quick Check (True/False)
• Under the absorption costing method, a portion of fixed
manufacturing overhead cost is allocated to each unit of product.

• Contribution margin and gross margin mean the same thing.

• When reconciling variable costing and absorption costing net

operating income, fixed manufacturing overhead costs deferred in
inventory under absorption costing should be deducted from
variable costing net operating income to arrive at the absorption
costing net operating income.
Quick Check (True/False)
• Under the absorption costing method, a portion of fixed manufacturing
overhead cost is allocated to each unit of product. (True)

• Contribution margin and gross margin mean the same thing. (False)

• When reconciling variable costing and absorption costing net operating

income, fixed manufacturing overhead costs deferred in inventory
under absorption costing should be deducted from variable costing net
operating income to arrive at the absorption costing net operating
income. (False)
Quick Check 2
In an income statement prepared using the variable costing method,
fixed selling and administrative expenses would:

A) be used in the computation of the contribution margin.

B) be used in the computation of net operating income but not in the
computation of the contribution margin.
C) be treated the same as variable manufacturing expenses.
D) not be used.
Quick Check 2
In an income statement prepared using the variable costing method,
fixed selling and administrative expenses would:

A) be used in the computation of the contribution margin.

B) be used in the computation of net operating income
but not in the computation of the contribution margin.
C) be treated the same as variable manufacturing expenses.
D) not be used.
Quick Check 3
A single-product company prepares income statements using both
absorption and variable costing methods. Manufacturing overhead cost
applied per unit produced under absorption costing in year 2 was the same as
in year 1. The year 2 variable costing statement reported a profit whereas the
year 2 absorption costing statement reported a loss. The difference in
reported income could be explained by units produced in year 2 being:
A) Less than units sold in year 2.
B) Less than the activity level used for allocating overhead to the product.
C) In excess of the activity level used for allocating overhead to the product.
D) In excess of units sold in year 2.
Quick Check 3
A single-product company prepares income statements using both
absorption and variable costing methods. Manufacturing overhead cost
applied per unit produced under absorption costing in year 2 was the same
as in year 1. The year 2 variable costing statement reported a profit whereas
the year 2 absorption costing statement reported a loss. The difference in
reported income could be explained by units produced in year 2 being:
A) Less than units sold in year 2.
B) Less than the activity level used for allocating overhead to the product.
C) In excess of the activity level used for allocating overhead to the product.
D) In excess of units sold in year 2.
Quick Check 4
Johnson Company produces a single product. Last year, the company
had 25,000 units in its ending inventory. Johnson's variable production
costs were $10 per unit and fixed manufacturing overhead costs were
$5 per unit. The company's net operating income last year was $10,000
higher under variable costing than it was under absorption costing.
Given these facts, the number of units of product in beginning
inventory last year must have been:
A) 24,000 units
B) 27,000 units
C) 23,000 units
D) 24,333 units
Quick Check 4
Johnson Company produces a single product. Last year, the company
had 25,000 units in its ending inventory. Johnson's variable production
costs were $10 per unit and fixed manufacturing overhead costs were $5
per unit. The company's net operating income last year was $10,000
higher under variable costing than it was under absorption costing.
Given these facts, the number of units of product in beginning
inventory last year must have been:
A) 24,000 units
B) 27,000 units [25,000 + (10,000/5)]
C) 23,000 units
D) 24,333 units
Quick Check 5
A company that produces a single product had a net operating
income of $85,500 using variable costing and a net operating income
of $90,000 using absorption costing. Total fixed manufacturing
overhead was $150,000, and production was 100,000 units. Between
the beginning and the end of the year, the inventory level:
A) increased by 4,500 units
B) decreased by 4,500 units
C) increased by 3,000 units
D) decreased by 3,000 units
Quick Check 5
A company that produces a single product had a net operating income
of $85,500 using variable costing and a net operating income of
$90,000 using absorption costing. Total fixed manufacturing overhead
was $150,000, and production was 100,000 units. Between the
beginning and the end of the year, the inventory level:
A) increased by 4,500 units
B) decreased by 4,500 units
C) increased by 3,000 units [4500/1.5]
D) decreased by 3,000 units
Quick Check 6
Welk Company produces a single product. Last year, the company had
16,000 units in its beginning inventory. During the year, the company's
variable production costs were $6 per unit and its fixed manufacturing
overhead costs were $4 per unit. The company's net operating income for
the year was $24,000 higher under absorption costing than it was under
variable costing. Given these facts, the number of units in the ending
inventory must have been:
A) 22,000 units
B) 10,000 units
C) 6,000 units
D) 4,000 units
Quick Check 6
Welk Company produces a single product. Last year, the company had 16,000
units in its beginning inventory. During the year, the company's variable
production costs were $6 per unit and its fixed manufacturing overhead costs
were $4 per unit. The company's net operating income for the year was
$24,000 higher under absorption costing than it was under variable costing.
Given these facts, the number of units in the ending inventory must have
been:
A) 22,000 units [16,000 + (24,000/4)]
B) 10,000 units
C) 6,000 units
D) 4,000 units
Quick Check 7
Olympia Company produces a single product. Last year, the company
had a net operating income of $92,000 using absorption costing and a
net operating income of $98,600 using variable costing. If the fixed
manufacturing overhead cost was $3.00 per unit for the last two years,
and if production was 18,000 units, then sales in units last year were:
A) 24,600
B) 20,200
C) 15,800
D) 15,000
Quick Check 7
Olympia Company produces a single product. Last year, the company
had a net operating income of $92,000 using absorption costing and a
net operating income of $98,600 using variable costing. If the fixed
manufacturing overhead cost was $3.00 per unit for the last two years,
and if production was 18,000 units, then sales in units last year were:
A) 24,600
B) 20,200 [18,000+((98,600-92,000)/3]
C) 15,800
D) 15,000
End of Chapter