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MS 104
PRODUCT COSTING
ABSORTION COSTIING (also called full costing, conventional costing)
- Costing method that includes all manufacturing costs (direct materials, direct labor, and
both variable and fixed manufacturing overhead) in the cost of a unit of product. It treats
fixed manufacturing overhead as product cost.
VARIABLE COSTING (also called direct costing)
- Costing method that includes only variable manufacturing costs (direct materials, direct
labor, and variable manufacturing overhead) in the cost of a unit of product. It treats fixed
manufacturing overhead as a period cost.
DISTINCTION BETWEEN PERIOD COSTS AND PRODUCT COSTS:
PERIOD COST
1. Refers to an items charged against current revenue on the basis of time period regardless
of the difference between production and sales volume.
2. Does not from part of the cost of inventory.
3. Diminishes income for the current period by its full amount
PRODUCT COST
1. Refers to an item included in product costing which is apportioned between the sold and
unsold units.
2. The portion of the cost, which has been allocated to the unsold units, becomes part of the
inventory.
3. Diminishes current income by that portion thereof identified with the sold units only with
the remainder being deferred to the next accounting period as part of the cost of ending
inventory.
PRINCIPAL DIFFERENCES BETWEEN VARIABLE AND CONVENTIONAL
ABSORPTION COSTING:
ABSORPTION COSTING VARIABLE COTING
1. Cost segregation Seldom segregates costs into Costs are segregated into
variable and fixed costs variable and fixed
2. Cost of inventory Cost of inventory includes all Costs of inventory includes
the manufacturing costs: only the variable
materials, labor, variable manufacturing costs:
factory overhead, and fixed Materials, labor, and variable
factory overhead factory overhead
3. Treatment of fixed factory Fixed factory overhead is Fixed factory overhead is
overhead treated as product costs treated as period cost.
4. Income statement Distinguishes between Distinguishes between
production and other costs. variable and 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 ex0pense during an 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 exceeds sales.
PRODUCT COSTING
DIFFERENCE IN NET ICOME UNDER ABSORPTION AND VARIABLE COSTING:
Variable and absorption costing method and accounting for fixed manufacturing overhead result
in different levels of net income in most cases. The differences are timing differences, i.e., when
to recognize the fixed manufacturing overhead as an expense. In variable costing, it is expensed
during the period when the overhead is incurred, while in absorption costing, it is expensed in the
period when the units to which such fixed overhead has been related are sold.
Production Equals Sales
When production is equal to sales, there is no change in inventory. Fixed overhead expensed
under absorption costing equals fixed overhead expensed under variable costing. Therefore,
absorption costing income equals variable coting income.
Production is Greater than Sales
When production is greater than sales, there is decrease in inventory. Fixed overhead expensed
under absorption is greater than fixed overhead expensed under variable costing. Therefore,
absorption income is less than variable costing income.
ARGUMENTS FOR THE USE OF VARIABLE COSTING
1. Variable costing report are simpler and more understandable.
2. Data needed for break-even and cost-volume-profit analyses are readily available.
3. The problems involved in allocating fixed cost are eliminated.
4. Variable costing is more compatible with the standard cost accounting system.
5. Variable costing reports provide useful information for price pricing decisions and other
decision-making problem encountered by management.
ARGUMENTS AGAINST VARIABLE COSTING
1. Segregation of costs into fixed and variable might be difficult, particularly in the case of
mixed costs.
2. The matching principle is violated by using variable costing which excludes fixed overhead
form product cost and charges the same to period costs regardless of production and sales.
3. With variable costing, inventory costs and other related accounts, such as working capital,
current ratio, and acid-test ratio are understated because of the exclusion of fixed overhead in a
compitation of product cost.
THROUGHPUT COSTING (or SUPERVARIABLE COSTING)
An extreme form of variable costing in which only direct material costs are included as
inventoriable costs. All other costs are costs of the period in which they are incurred.
Throughput margin = Revenue – Direct material costs of the goods sold
PROBLEM
1. Sports Innovators has developed a new design to produce hurdles that are used in track and field
competition. The company's hurdle design is innovative in that the hurdle yields when hit by a
runner and its height is extraordinarily easy to adjust. Management estimates expected annual
capacity to be 90,000 units; overhead is applied using expected annual capacity. The company's
cost accountant predicts the following 2001 activities and related costs:
Standard unit variable manufacturing costs P12

Variable unit selling expense P5
Fixed manufacturing overhead P480,000
Fixed selling and administrative expenses P136,000
Selling price per unit P35
Units of sales 80,000
Units of production 85,000
Units in beginning inventory 10,000
Other than any possible under- or overapplied fixed overhead, management expects no variances
from the previous manufacturing costs. Under- or overapplied fixed overhead is to be written off
to Cost of Goods Sold.
Required:
1. Determine the amount of under- or overapplied fixed overhead using (a)
variable costing and (b) absorption costing.
2. Prepare projected income statements using (a) variable costing and (b)
absorption costing.
2. Sherrill Corporation produces a single product. The following is a cost structure applied to its
first year of operations.
Sales price P15 per unit

Variable costs:
SG&A P2 per unit
Production P4 per unit
Fixed costs (total cost incurred for the year):
SG&A P14,000
Production P20,000
During the first year, Sherrill Corporation manufactured 5,000 units and sold 3,800. There was
no beginning or ending work-in-process inventory.
a. How much income before income taxes would be reported if Stanley uses
absorption costing?
b. How much income before income taxes would be reported if variable costing
was used?
c. Show why the two costing methods give different income amounts.

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MS 104

Standard unit variable manufacturing costs P12

Sales price P15 per unit

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