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MAS.2904-Variable & Absorption Costing OCT. 2020

LECTURE NOTES

1. Variable costing treats only those costs of production manufacturing overhead costs are expensed under
that vary with output as product costs. Ordinarily, variable costing, the net income reported under
direct materials, direct labor and variable absorption costing will be less than the net income
manufacturing overhead costs would be included in reported under variable costing.
product costs under variable costing. Fixed 4. Long-term differences in income. Over an extended
manufacturing overhead is treated as a period cost period of time, the cumulative net income figures
and is immediately charged off against revenue each reported under absorption costing and variable
period. costing will be about the same; they will differ only
2. Absorption costing treats all costs of production as by the amount of fixed manufacturing overhead cost
product costs, regardless of whether they are variable in ending inventories under absorption costing.
or fixed in nature. Under the absorption costing Cumulative net income figures will be identical
method, a portion of fixed manufacturing overhead is whenever ending inventories are reduced to zero.
allocated to each unit of product. 5. Changes in production volume. Variable costing net
income is not affected by changes in production
Comparison of Absorption and Variable Costing. volume. Absorption costing net income is affected by
When comparing absorption costing and variable costing changes in production volume. For a particular level
income statements, a number of points should be noted: of sales, net income under absorption costing will
1. Deferral of fixed manufacturing costs under increase as the level of output increases and hence
absorption costing. Under the absorption costing inventories increase.
method, if inventories increase then a portion of the
fixed manufacturing overhead costs of the current Advantages of the Contribution Approach. There are
period is deferred to future periods through the a number of advantages to using variable costing (and
inventory account. When the units are later taken out the contribution approach) in internal reports and
of inventory and sold, the deferred fixed costs flow analysis.
through to the income statement. 1. More useful for CVP analysis. Variable costing
2. Differences in inventories under the two statements provide data that are immediately useful
methods. The ending inventory figures under the for CVP analysis since they categorize costs on the
variable costing and absorption costing methods are basis of their behavior.
different. Under variable costing, only the variable 2. Income is not affected by changes in production
manufacturing costs are included in inventory. Under volume. Under absorption costing, reported net
absorption costing, both variable and fixed income is affected by changes in production since
manufacturing costs are included in inventory. fixed costs are spread across more or fewer units.
This can distort income and may even result in income
Suitability for CVP analysis. The absorption costing moving in an opposite direction from sales. This does
income statement is not well suited for providing data for not occur under variable costing.
CVP computations since it makes no distinction between 3. Avoids misunderstandings concerning unit product
fixed and variable costs. In contrast, the variable costing costs. Absorption costing unit product costs can be
method classifies costs by behavior and is very useful in easily misinterpreted as variable costs since they are
setting-up CVP computations. stated on a per unit basis. Such a misperception can
lead to serious errors in making decisions. Variable
Extended Comparison of Income Data. costing avoids this problem since unit costs include
1. Production equals sales (no change in inventories). only variable costs.
When production equals sales, there is no change in 4. Fixed costs are more visible. The impact of fixed costs
inventories. If there is no change in inventories, then on profits is emphasized because the total amount of
there is no change in the fixed manufacturing such costs for the period appears separately and is
overhead costs in inventories under absorption highlighted in the income statement rather than being
costing. buried in cost of goods sold and ending inventory.
2. Production exceeds sales (inventories increase). 5. Understandability. Managers may find it easier to
When production exceeds sales, inventories grow. If understand variable costing reports because data are
inventories grow, then some of the current fixed organized by behavior and because variable costing is
manufacturing overhead costs will be deferred in much closer to a cash flow concept.
inventories under absorption costing. Since all of the 6. Control is facilitated. Variable costing ties in with cost
current fixed manufacturing overhead costs are control methods such as flexible budgets.
expensed under variable costing, the net income 7. Incremental analysis is more straight-forward.
reported under absorption costing will be greater than Variable cost corresponds closely with the current
the net income reported under variable costing. out-of-pocket expenditure necessary to produce and
3. Sales exceeds production (inventories decrease). sell products and services and can therefore be used
When sales exceeds production, inventories shrink. If more readily in incremental analysis than absorption
inventories decrease, then some of the fixed costing data. And since variable costing net income is
manufacturing overhead costs that had been deferred closer to net cash flow than absorption costing net
in inventories in previous periods will be released to income, it is likely to be more useful to companies
the income statement as a charge against income as that have cash flow problems.
well as all of the current fixed manufacturing
overhead costs. Since only the current fixed

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EXERCISES

Problem 1. Crown Company provided the following 4. Assume the same data as in requirement "3."
information for 2020. Compute the contribution margin that would be
Sales revenue (at P200 per unit) P1,800,000 reported on a variable-costing income statement.
Fixed production costs 240,000
Variable production costs (P80 per unit) 720,000 Problem 4. Gensun Company, which has only one
Fixed selling expenses 600,000 product, has provided the following data concerning
Variable selling expenses (P20 per unit) 180,000 its most recent month of operations:

The company uses actual costing. It has no beginning Selling price P121
inventory of finished goods and work in process.
Required: Units in beginning inventory 400
1. Assume that the number of units produced equals Units produced 5,600
the number of units sold. Prepare income statement Units sold 5,800
using: Units in ending inventory 200
1a) functional (absorption costing) income
statement Variable costs per unit:
1b) contribution (variable costing) income Direct materials P33
Statement Direct labor 49
Variable manufacturing overhead 1
2. Without preparing any income statement, compute Variable selling and administrative 4
the amount of income using each type of product
costing assuming the company produced the 10,000 Fixed costs:
units during the year. Fixed manufacturing overhead P140,000
Fixed selling and administrative 52,200
Problem 2. Luzon Manufacturing Company began its
operations on January 1, 2020, and produces a single The company produces the same number of units
product that sells for P45 per unit. During 2020, 60,000 every month, although the sales in units vary from
units of the product were produced, 55,000 of which month to month. The company's variable costs per
were sold. There was no work in process inventory at unit and total fixed costs have been constant from
the en of the year. Manufacturing and marketing and month to month.
administrative expenses for 2020 were as follows:
Fixed Variable Required: Compute the amount of income under:
Materials P12 per unit 1. Variable costing method.
produced 2. Absorption costing method.
Direct labor P8 per unit produced
Factory OH P420,000 P6 per unit produced Problem 5. El Rey Company had net income for the
Marketing & P180,000 P4 per unit sold first 10 months of the current year of P300,000. One
admin. hundred thousand units were manufactured during the
period, and 100,000 units were sold. Fixed
Required. manufacturing overhead was P3M over the 10-month
1. Compute the unit cost using variable costing. period. There are no selling and administrative
2. Compute the unit cost using absorption costing. expenses for El Rey Company. Both variable and fixed
3. Compute the amount of income under: costs are expected to continue at the same rates for the
a. Traditional costing balance of the year (i.e., fixed costs at P300,000 per
b. Variable costing month and variable costs at the same variable cost per
c. Throughput costing unit). There were 10,000 units in inventory on October
31. Nineteen thousand units are to be produced and
Problem 3. The economic data taken from Stayathome 20,000 units are to be sold in total over the last two
Corporation's October accounting records follows. months of the current year. Assume the standard unit
variable cost is the same in the current year as in the
Direct materials used P800,000 previous year.
Direct labor 450,000
Variable factory overhead 250,000 1. If operations proceed as described, will net income be
Fixed factory overhead 600,000 higher under variable or absorption costing for the
Variable selling & adm costs 300,000 current year in total? Why?
Fixed selling & adm costs 220,000 2. If operations proceed as described, what will net
Sales revenue 2,850,000 income for the year in total be under: a) variable
costing; and b) absorption costing? Ignore income
Required: taxes.
1. Assuming the use of variable costing, compute the
inventoriable costs for the month. Problem 6. Relevant Corporation has fixed
2. Compute the month's inventoriable costs by using manufacturing cost of P6 per unit. Consider the
absorption costing. three independent cases that follow.
3. Assume that anticipated and actual production totaled
40,000 units, and that 38,000 units were sold during Case A: Absorption- and variable costing net income
November. Determine the amount of fixed each totaled P160,000 in a period when the firm
manufacturing overhead and fixed selling and produces 20,000 units.
administrative costs that would be expensed for the Case B: Absorption-costing net income totaled
month under (1) variable costing and (2) absorption P180,000 in a period when finished-goods
costing. inventory level rises by 8,000 units.

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Case C: Absorption-costing net income and variable- a. Net operating income fluctuates directly with
costing net income respectively totaled P250,000 changes in sales volume.
and P274,000 in a period when the beginning b. Fixed production and fixed selling costs are
finished-goods inventory was 14,000 units. considered to be product costs.
c. Unit product costs can change as a result of
Required: changes in the number of units manufactured.
d. Variable selling expenses are included in product
1. In Case A, how many units were sold during the costs.
period?
2. In Case B, how much income would Relevant 6. Which of the following is true about income statement
Company report under variable costing? that uses variable costing?
3. In Case C, how many units were in the ending a. The cost of a unit of product changes because of
finished-goods inventory? changes in the number of units manufactured
b. Profits fluctuate with sales
Problem 7. Front Company has per-unit fixed and c. An idle facility variation is calculated
variable manufacturing costs of P12 and P4, d. None of the given choices
respectively. Variable selling and administrative
costs are P9 per unit and fixed selling and 7. Advocates of variable costing argue that:
administrative expenses are P90,000. Consider the a. fixed production costs should be added to
two independent cases that follow for the firm. inventory because such costs have future service
potential and therefore are inventoriable as an
Case A: Variable-costing net income, P60,000; sales, asset.
25,000 units; production, 30,000 units b. fixed production costs should be capitalized as
Case B: Variable-costing net income, P80,000; sales, an asset and amortized over future periods when
27,500 units; production, 25,000 units benefits from such costs are expected to be
received.
Required: c. fixed production costs should be charged to the
1. From a product-costing perspective, what is the period in which they are incurred unless sales do
basic difference between absorption costing and not equal production in which case any
variable costing? difference should be capitalized as an asset and
2. Compute Front's absorption-costing net income amortized over future periods.
in Case A. d. fixed production costs should be charged to the
3. Compute Front's absorption-costing net income period in which they are incurred.
in Case B.
8. In an income statement prepared as an internal
MULTIPLE CHOICE report using variable costing, variable selling and
1. If a firm produces more units than it sells, absorption administrative expenses would:
costing, relative to variable costing, will result in a. not be used.
a. higher income and assets b. be used in the computation of the contribution
b. lower income but lower assets margin.
c. higher income but lower assets c. be used in the computation of net operating
d. lower income and assets income but not in the computation of the
contribution margin.
2. Under absorption costing, if sales remain constant from d. be treated the same as fixed selling and
period 1 to period 2, the company will report a larger administrative expenses.
income in period 2 when
a. period 2 production exceeds period 1 production 9. Under variable costing:
b. period 1 production exceeds period 2 production a. net operating income will tend to move up and
c. variable production costs are larger in period 2 than down in response to changes in levels of
period 1 production.
d. fixed production costs are larger in period 2 than b. inventory costs will be lower than under
period 1 absorption costing.
c. net operating income will tend to vary inversely
3. The variable costing format is often more useful to with production changes.
managers than the absorption costing format because d. net operating income will always be higher than
a. costs are classified by their behavior under absorption costing.
b. it is required for external reporting
b. costs are always lower 11. Under absorption costing, fixed manufacturing
c. it justifies higher product prices overhead costs:
a. are deferred in inventory when production
exceeds sales.
4. When a firm prepares financial reports using
b. are always treated as period costs.
absorption costing
c. are released from inventory when production
a. profits will always increase with increase in sales
exceeds sales.
b. profits will always decrease with decreases in sales
d. none of these.
c. profits may decrease with increased sales even if
there is no change in selling prices and costs
12. __________ method(s) expense(s) variable
d. decreased output and constant sales result in
marketing costs in the period incurred.
increased profits
a. Variable costing
b. Absorption costing
5. Which of the following is true of a company that uses
c. Throughput costing
absorption costing?
d. All of these answers are correct.

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13. The contribution-margin format of the income a. P30,000 c. P67,500

statement: b. P(7,500) d. P45,000
a. is used with absorption costing
b. highlights the lump sum of fixed manufacturing 19. What was the total amount SG&A expense incurred
costs by X Co.?
c. distinguishes manufacturing costs from a. P30,000 c. P6,000
nonmanufacturing costs b. P62,500 d. P45,000
d. calculates gross margin
20. For its most recent fiscal year, a firm reported that
14. The gross-margin format of the income statement: its contribution margin was equal to 40% of sales
a. distinguishes between manufacturing and and that its net income amounted to 10% of sales.
nonmanufacturing costs If its fixed costs for the year were P60,000, how
b. distinguishes variable costs from fixed costs much were sales?
c. is used with variable costing a. P150,000 c. P600,000
d. calculates contribution margin b. P200,000 d. Undeterminable

15. Variable costing considers which of the following to be 21. At its present level of operations, a small
product costs? manufacturing firm has total variable costs equal to
Fixed Fixed Variable Variable 75% of sales and total fixed costs equal to 15% of
Mfg S&A Mfg Costs S&A sales. Based on variable costing, if sales change by
a. Yes No Yes No P1.00, income will change by
b. Yes No Yes Yes a. P0.25 c. P0.75
c. No No Yes Yes b. P0.10 d. Undeterminable
d. No No Yes No
The following information should be used to answer
16. Dredger Company manufactures a single product question nos. 22 through 25.
using standard costing. Variable production costs are
P12 and fixed production costs are P125,000. Dredger Simple Corp. produces a single product. The following
uses a normal activity of 12,500 units to set its cost structure applied to their first year of operations,
standard costs. Dredger began the year with 1,000 2020:
units in inventory, produced 11,000 units, and sold Variable costs:
11,500 units. The standard costs of goods sold under SG&A P2.00 per unit
absorption costing would be Production 4.00 per unit
Fixed Costs (total cost incurred for the year)
a. P115,000 c. P242,000
SG&A . P14,000
b. P132,000 d. P253,000
Production P20,000

17. You obtain the following information regarding fixed 22. Assume for this question only, that during 2020
production costs from a manufacturing firm for fiscal Simple Corp. manufactured 5,000 units and sold
year 2016: 3,800. There was no beginning or ending work-in-
process inventory. How much larger or smaller
Fixed costs in the beginning inventory P 16,000 would Simple Corp.’s income be if it uses absorption
Fixed costs incurred this period P100,000 rather than variable costing?
a. The absorption costing income would be P6,000
Which of the following statements is not true? larger
a. The maximum amount of fixed production costs b. The absorption costing income would be P6,000
that this firm could deduct using absorption costs smaller
in 2016 is P116,000 c. The absorption costing income would be P4,800
larger
b. The maximum difference between this firm’s 2016 d. The absorption costing income would be P4,000
income based on absorption costing and its income smaller
based on variable costing is P16,000
c. Using variable costing, this firm will deduct no 23. Assume for this question only, that Simple Corp.
more than P100,000 for fixed production costs manufactured and sold 5,000 units in 2020. At this
level of activity they had an income of P30,000 using
d. If this firm produced substantially more units than variable costing. What was the sales price per unit?
it sold in 2016, variable costing will probably yield a. P16.00 c. P12.80
a lower income than absorption costing b. P18.80 d. P14.80
Question no. 18 and 19 are based on the following data
which are available for X Co. for its first year of 24. Assume for this question only, that Simple Corp.
operations: produced 5,000 units and sold 4,500 units in 2020.
Sales in units 5,000 If Simple uses absorption costing, it would deduct
Production in units 8,000 period costs of
Manufacturing costs: a. P24,000 c. P27,000
Direct labor P3 per unit b. P34,000 d. P23,000
Direct materials P5 per unit
Variable overhead P1 per unit 25. Assume for this question only, that Simple Corp.
Fixed overhead P100,000 manufactured 5,000 units and sold 4,000 in 2020.
Net income (absorption method) P 30,000 If Simple employs a costing system based on
Sales price per unit P 40 variable costs, the company would end 2020 with a
finished goods inventory of
18. What would X Co. have reported as its income a. P4,000 c. P6,000
before tax if it had used variable costing? b. P8,000 d. P5,000

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Questions 26 & 27 are based on the following: 30. Lauder Company produces a single product. During
A Co. B Co. C Co. March, the company had net operating income under
Sales P100 P100 P100 absorption costing that was P3,500 lower than under
Variable costs ( 10) (20) (30) variable costing. The company sold 7,000 units in
Contribution margin P 90 P 80 P 70 March, and its variable costs were P7 per unit, of which
Fixed costs 30 20 10 P3 was variable selling expense. If fixed manufacturing
Profit P60 P 60 P 60 overhead was P2 per unit under absorption costing, then
how many units did the company produce during March?
26. Within the relevant range, if sales go up by P1 for a. 5,250 units c. 6,500 units
each firm, which firm will experience the greatest b. 8,750 units d. 6,125 units
increase in profit?
a. Company A c. Company C 31. Company B produces a single product. Last year, the
b. Company B d. Not determinable company had 16,000 units in its beginning inventory.
During the year, the company's variable production
27. Within the relevant range, if sales go up by one unit costs were P6 per unit and its fixed manufacturing
for each firm, which firm will experience the greatest overhead costs were P4 per unit. The company's net
increase in net income? operating income for the year was P24,000 higher under
a. Company A c. Company C absorption costing than it was under variable costing.
b. Company B d. Not determinable Given these facts, the number of units in the ending
inventory must have been:
28. Southseas Corp. uses a standard cost system. The a. 22,000 units c. 6,000 units
standard cost per unit of one of its products are as b. 10,000 units d. 4,000 units
follows:
ITEMS 32 and 33 ARE BASED ON THE FOLLOWING:
Direct Materials P4.00
Renault Company produces convertible cubicles that sell
Direct labor 6.00
for P400. Standard variable manufacturing cost is P100
Factory overhead
and the standard fixed manufacturing cost is P150,
Variable 3.00
based on budgeted fixed costs of P15,000,000 and
Fixed (based on a normal
budgeted production of 100,000 units. During 2020,
capacity of 10,000 units) 2.00
Renault produced 96,000 units of convertible cubicles
Total 15.00
and sold P90,000 units. Actual costs incurred were:
Fixed manufacturing P14,870,000
Beginning inventory 2,000 units
Variable manufacturing 9,550,000
Production 8,000 units
Selling and administrative
Units sold (selling price P50) 7,000 units
(all fixed) 10,550,000
Actual costs:
Direct materials P 35,000
There were no beginning inventories.
Direct labor 50,000
Variable overhead 23,000
32. For the year 2020:
Fixed 18,000
a. Renault’s income under absorption costing is
Variable selling and adm. 60,000
P1,630,000.
Fixed selling and adm. 35,000
b. Renault’s actual cost of goods sold is
P22,920,000
Variances are closed to cost of sales monthly
c. Renault’s contribution margin under variable
How much are the net income under absorption
costing is P30,000,000.
costing and variable costing methods?
d. The total fixed costs charged to expense during
Absorption Variable
the period under variable costing is
a. P144,000 P143,000
P25,550,000.
b. 143,000 144,000
c. 144,000 142,000
33. Which of the following statements regarding
d. 142,000 144,000
Renault’s cost variances is true?
a. Renault’s fixed budget variance is zero.
29. A manufacturing company that produces a single
b. Renault’s volume variance is P600,000,
product has provided the following data concerning its
unfavorable.
most recent month of operations:
c. Renault’s variable efficiency variance is P50,000,
Selling price, P85 favorable.
Units in beginning inventory, 0 d. Renault’s variable spending variance is
Units produced, 2,900 P180,000, favorable.
Units sold, 2,700
Units in ending inventory, 200 34. Mercury Products began operating on January 3 of the
Variable costs per unit: current year. Standard costs were established in early
Direct materials, P22 January assuming a normal production volume of 160
Direct labor, P13 units. However, Mercury Products produced only 140
Variable manufacturing overhead, P3 units of product and sold only 100 units at a selling price
Variable selling and administrative, P5 of P180 per unit during the current year. Variable costs
Fixed costs: totaled P7,000, of which 60% were manufacturing and
Fixed manufacturing overhead, P46,400 40% were selling. Fixed costs totaled P11,200, of which
Fixed selling and administrative, P51,300 50% were manufacturing and 50% were selling.
What is the net operating income for the month under Mercury had no raw materials or work in process
variable costing? inventories at the end of the year. Actual input prices
a. P 8,100 c. P18,900 per unit and actual input quantities per unit of product
b. P15,700 d. P 3,200 were equal to standard.

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EXCEL PROFESSIONAL SERVICES, INC.

Which of the following is true? b. determining a competitive selling price

a. Using variable costing, Mercury would have c. external reporting to shareholders
operating income of P12,200. d. income tax reporting
b. Using absorption costing, Mercury’s cost of goods
sold at standard cost is P7,200. 41. If the unit level of inventory increases during an
c. Under variable costing, the total fixed accounting period, then:
manufacturing cost that Mercury would charge as a. less operating income will be reported under
expense during the period is P4,900. absorption costing than variable costing
d. Using absorption costing, Mercury would have b. more operating income will be reported under
operating income of P2,400. absorption costing than variable costing
c. operating income will be the same under
35. What is the primary difference between variable and absorption costing and variable costing
absorption costing? d. the exact effect on operating income cannot be
a. inclusion of fixed selling expenses in product determined
costs 42. The difference between operating incomes under
b. inclusion of variable factory overhead in period variable costing and absorption costing centers on
costs how to account for:
c. inclusion of fixed selling expenses in period costs a. direct materials costs
d. inclusion of fixed factory overhead in product b. fixed manufacturing costs
costs c. variable manufacturing costs
d. Both b and c are correct.
36. When monthly production volume is constant and
sales volume is less than production, net income 43. One possible means of determining the difference
determined with variable costing procedures will between operating incomes for absorption costing
a. always be greater than net income determined and variable costing is by:
using absorption costing. a. subtracting sales of the previous period from
b. always be less than net income determined using sales of this period
absorption costing. b. subtracting fixed manufacturing overhead in
c. be equal to net income determined using beginning inventory from fixed manufacturing
absorption costing. overhead in ending inventory
d. be equal to contribution margin per unit times c. multiplying the number of units produced by the
units sold. budgeted fixed manufacturing cost rate
d. adding fixed manufacturing costs to the
37. Assume the following information for a product line: production-volume variance
Sales P500,000
Variable manufacturing expenses 100,000 44. When comparing the operating incomes between
Direct fixed manufacturing expenses 75,000 absorption costing and variable costing, and
Variable selling and administrative beginning finished inventory exceeds ending finished
50,000
expenses inventory, it may be assumed that:
Direct fixed selling and admin. expenses 60,000 a. sales increased during the period
b. variable cost per unit is less than fixed cost per
What is the segment margin of the product line? unit
a. P400,000 c. P350,000 c. there is an unfavorable production-volume
b. P325,000 d. P215,000 variance
d. variable costing operating income exceeds
38. The sales price variance is created by a difference absorption costing operating income
between
a. actual and standard contribution margin. 45. Which of the following statements is FALSE?
b. actual and expected sales price. a. Absorption costing allocates fixed manufacturing
c. expected and standard net income. overhead to actual units produced during the
d. actual and expected sales volume. period.
b. Nonmanufacturing costs are expensed in the
39. Which of the following cost(s) are inventoried when future under variable costing.
using variable costing? c. Fixed manufacturing costs in ending inventory
a. direct manufacturing costs are expensed in the future under absorption
b. variable marketing costs costing.
c. fixed manufacturing costs d. Operating income under absorption costing is
d. Both a and b are correct. higher than operating income under variable
costing when production units exceed sales
40. Absorption costing is required for all of the following units.
EXCEPT:
a. generally accepted accounting principles

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