Variable Costing—A Tool for Management Show
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Learning Objectives
Chapter Overview A. Overview of Variable and Absorption Costing. At least two methods can be used in manufacturing companies to value units of product for accounting purposes—absorption costing and variable costing. These methods differ only in how they treat fixed manufacturing overhead costs.
B. Comparison of Absorption and Variable Costing. When comparing absorption costing and variable costing income statements, a number of points should be noted:
C. Extended Comparison of Income Data. Exhibit 7-3 in the text presents a comparison of absorption costing and variable costing income statements over three years in which production is constant but sales vary. Exhibit 7-6 in the text also presents comparative income statements over three years but holds annual sales constant and varies annual production. From these Exhibits, several generalizations can be drawn. (All of these generalizations assume the LIFO inventory flow assumption is being used. The generalizations may not hold in some rare cases if a company uses an inventory flow assumption other than LIFO.)
D. The Matching Principle. Accountants and managers have been arguing for decades concerning the relative merits of absorption and variable costing. In practice, absorption costing is used far more than variable costing even for internal reports. The reasons for this are not entirely clear, although the perception that absorption costing is required for external reporting undoubtedly plays a key role. The argument for using absorption costing in external reports seems to be based on the matching principle.
E. Advantages of the Contribution Approach. There are a number of advantages to using variable costing (and the contribution approach) in internal reports and analysis.
F. Impact of JIT Inventory Methods. When companies use JIT methods for controlling their operations, the distortions of income that can occur under absorption costing largely (or completely) disappear.
In what instances would net income under variable costing exceed the net income under absorption costing?If sales are more than production, then net income under variable costing will exceed net income under absorption costing. Is absorption costing higher or lower than variable costing?Sales greater than Production. This will result in net income under variable costing being greater than under absorption costing. With absorption costing, all manufacturing costs are captured in the finished goods inventory account, and as those goods are sold, those costs become expenses. Why is income calculated under full absorption costing will be greater than income calculated under variable costing when production exceeds sales?When inventory increases, under the absorption costing, the fixed manufacturing costs are postponed to the ending stock resulting in a reduced cost burden for the current period. As a result, the income under full absorption costing will always exceed the income under variable costing when inventory increases. When inventory increases absorption costing net operating income is higher than variable?When inventory increases, absorption costing net operating income is higher than variable costing net income but to the fix manufacturing overhead: Deferred in the inventory account on the balance sheet. When the number of units produced equals the number of units sold: no change in inventories occurs. When units produced equals units sold income under absorption costing will be?(1) When units produced equals units sold, profit is the same for both costing approaches. (2) When units produced is greater than units sold, absorption costing yields the highest profit.
When units sold exceed units produced income under absorption costing is higher than income under variable costing?Step 2: Difference in operating income
When units produced exceed units sold the operating income from the absorption method is higher than the operating income from the variable costing method because under absorption costing some fixed manufacturing overhead remains unexpended and reflected in the balance sheet.
What happens when production is greater than sales?Explanation: If production exceeds sales, the profit under absorption costing is higher as compared to variable costing. This is due to the deferral of fixed manufacturing overhead costs to the next period in ending inventory, leading to reduced cost of goods sold for the current period and hence a higher profit.
When production exceeds sales the net operating income reported under absorption costing is?When production exceeds sales, the net operating income reported under absorption costing generally will be: greater than net operating income reported under variable costing.
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