Absorption costing Absorption costing Group no-4 Apparel Production-6 National Institute Of Fashion Technology Mumbai
Nov 15, 2014
Absorption costingAbsorption costing
Group no-4Apparel Production-6National Institute Of Fashion TechnologyMumbai
Absorption costing
• Costing method which involves or “absorbs” all the costs necessary to produce the product into its saleable form.
The layman’s language
The only cost of driving my caron a 200 mile trip today is
$12 for gasoline.
VariableCosting
No! You must consider these costs too!
AbsorptionCosting
Cost Per month Per day
Car payment 300.00$ 10.00$
Insurance 60.00 2.00
Two Costing MethodsTwo Costing Methods
Used for external financial reporting
Includes direct materials, direct labor, variable factory overhead, and fixed factory overhead as part of total product cost
Absorption CostingAbsorption Costing
Two Costing MethodsTwo Costing Methods
Variable CostingVariable Costing
Used for internal planning and decision making
Does not include fixed factory overhead as a product cost
Absorption Costing Compared to Absorption Costing Compared to Variable CostingVariable Costing
Variable Costing
Absorption Costing
Cost of Goods ManufacturedCost of Goods Manufactured
Cost of Goods ManufacturedCost of Goods Manufactured
DirectDirectMaterialsMaterials
DirectDirectLaborLabor
VariableVariableFactory OHFactory OH
FixedFixedFactory OHFactory OH
Period ExpensePeriod Expense
Overview of Absorption and Variable Costing
Direct Materials
Direct Labor
Variable Manufacturing Overhead
Fixed Manufacturing Overhead
Variable Selling and Administrative Expenses
Fixed Selling and Administrative Expenses
VariableCosting
AbsorptionCosting
ProductCosts
PeriodCosts
ProductCosts
PeriodCosts
• An example of income comparisons using variable and absorption costings
ABC Co. produces a single product with the following information available:
Unit Cost Computations
Unit product cost is determined as follows:
Selling and administrative expenses arealways treated as period expenses and
deducted from revenue.
Unit Cost Computations
Absorption CostingSales (20,000 × $30) 600,000$ Less cost of goods sold: Beginning inventory -$ Add COGM (25,000 × $16) 400,000 Goods available for sale 400,000 Ending inventory (5,000 × $16) 80,000 320,000 Gross margin 280,000 Less selling & admin. exp. Variable FixedNet operating income
ABC Co. had no beginning inventory, produced 25,000 units and sold 20,000 units this year.
Income Comparison of Absorption and Variable Costing
ABC Co. had no beginning inventory, produced 25,000 units and sold 20,000 units this year.
Absorption CostingSales (20,000 × $30) 600,000$ Less cost of goods sold: Beginning inventory -$ Add COGM (25,000 × $16) 400,000 Goods available for sale 400,000 Ending inventory (5,000 × $16) 80,000 320,000 Gross margin 280,000 Less selling & admin. exp. Variable (20,000 × $3) 60,000$ Fixed 100,000 160,000 Net operating income 120,000$
Income Comparison of Absorption and Variable Costing
Variable CostingSales (20,000 × $30) 600,000$ Less variable expenses: Beginning inventory -$ Add COGM (25,000 × $10) 250,000 Goods available for sale 250,000 Less ending inventory (5,000 × $10) 50,000 Variable cost of goods sold 200,000 Variable selling & administrative expenses (20,000 × $3) 60,000 260,000 Contribution margin 340,000 Less fixed expenses: Manufacturing overhead 150,000$ Selling & administrative expenses 100,000 250,000 Net operating income 90,000$
Now let’s look at variable costing by ABC Co.Variable
costsonly.
All fixedmanufacturing
overhead isexpensed.
Income Comparison of Absorption and Variable Costing
Let’s compare the methods.
Income Comparison of Absorption and Variable Costing
Reconciliation
Variable costing net operating income 90,000$ Add: Fixed mfg. overhead costs deferred in inventory (5,000 units × $6 per unit) 30,000 Absorption costing net opearting income 120,000$
Fixed mfg. overhead $150,000 Units produced 25,000 units
= = $6.00 per unit
We can reconcile the difference betweenabsorption and variable income as follows:
Extending the Example
Let’s look at thesecond yearof operations
for ABCCompany.
ABC Co. Year 2 In its second year of operations, ABC Co. started with
an inventory of 5,000 units, produced 25,000 units and sold 30,000 units.
ABC Co. Year 2
Unit product cost is determined as follows:
No change in ABC’scost structure.
ABC Co. Year 2
Now let’s look at ABC’s income statementassuming absorption costing is used.
Absorption CostingSales (30,000 × $30) 900,000$ Less cost of goods sold: Beg. inventory (5,000 × $16) 80,000$ Add COGM (25,000 × $16) 400,000 Goods available for sale 480,000 Less ending inventory - 480,000 Gross margin 420,000 Less selling & admin. exp. Variable (30,000 × $3) 90,000$ Fixed 100,000 190,000 Net operating income 230,000$
ABC Co. Year 2
These are the 25,000 unitsproduced in the current period.
ABC Co. Year 2
Next, we’ll look at ABC’s income statementassuming is used.
ABC Co. Year 2Variable
costsonly.
All fixedmanufacturing
overhead isexpensed.
Reconciliation
Variable costing net operating income 260,000$ Deduct: Fixed manufacturing overhead costs released from inventory (5,000 units × $6 per unit) 30,000 Absorption costing net operating income 230,000$
We can reconcile the difference betweenabsorption and variable income as follows:
Fixed mfg. overhead $150,000 Units produced 25,000 units
= = $6.00 per unit
Summary
IFIF Units Sold < Units produced
THENTHEN Variable Costing < Absorption CostingIncome Income
IFIF Units Sold > Units produced
THENTHEN Variable Costing > Absorption CostingIncome Income
• when production > sales, absorption costing net income will be greater than variable costing net income due to the current period fixed costs held in inventory.
• when production < sales, absorption costing net income will be less than variable costing net income due to the “old” fixed costs released from inventory.
• when production = sales, absorption costing net income and variable costing net income will be equal.
VariableCosting
Absorptioncosting product costs
are misleading fordecision making.
They are the numbers that appear on our
external reports.
AbsorptionCosting
Variable versusAbsorption Costing
Variable cost $10Fixed manufacturing overhead $100,000Units sold 10,000
Units Produced
Total Variable Cost
Fixed Manufacturing
Overhead
Total Manufacturing
Cost
Average Manufacturing
CostCost of
Goods Sold10,000 $100,000 $100,000 $200,000 20.00$ 200,000$ 12,000 $120,000 $100,000 $220,000 18.33$ 183,333$ 14,000 $140,000 $100,000 $240,000 17.14$ 171,429$ 16,000 $160,000 $100,000 $260,000 16.25$ 162,500$ 18,000 $180,000 $100,000 $280,000 15.56$ 155,556$ 20,000 $200,000 $100,000 $300,000 15.00$ 150,000$
Absorption CostingCost of goods sold decreases because production
exceeds sales, leaving a portion of fixedmanufacturing costs in inventory.
COGS for 10,000 units
$100,000
$150,000
$200,000
Number of units produced
CO
GS
Absorption CostingCost of goods sold decreases because production
exceeds sales, leaving a portion of fixedmanufacturing costs in inventory.
Impact of JIT Inventory Methods
In a JIT inventory system . . .
Productiontends to equalsales . . .
So, the difference between variable andabsorption income tends to disappear.
Management’s Use of Costing MethodsManagement’s Use of Costing MethodsManagement’s Use of Costing MethodsManagement’s Use of Costing Methods
1. Controlling costs
2. Pricing products
3. Planning production
4. Analyzing market segments
5. Analyzing contribution margins
Variable costing reports and absorption costing reports are useful in the following situations:
Accounting Reports and Accounting Reports and Management DecisionsManagement DecisionsAccounting Reports and Accounting Reports and Management DecisionsManagement Decisions
ACCOUNTING REPORTS
Absorption Costing and Variable Costing
MANAGEMENT
MANAGEMENT
DECISIONS
Controlling Controlling CostsCosts
PricingPricingPlanning Planning
ProductionProduction
Analyzing Analyzing Market Market
SegmentsSegments
Analyzing Analyzing Contribution Contribution
MarginsMargins
ACTUAL PLANNED
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