Absorption and Variable Costing
Mellon Co. produces a single product
with the following information available:
Mellon Co. had no beginning inventory, produced 25,000 units and sold 20,000 units this year at $30 each.
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Absorption and Variable Costing Chapter 8Absorption and Variable CostingThe difference between absorption and variable costing is the treatment of fixed manufacturing overhead. Mellon Co. produces a single product with the following information available:Absorption and Variable CostingUnit product cost is determined as follows:Absorption and Variable CostingSelling and administrative expenses are always treated as period expenses and deducted from revenue.Mellon Co. had no beginning inventory, produced 25,000 units and sold 20,000 units this year at $30 each.Absorption Costing Income StatementsVariable Costing Income StatementsNow let’s look at variable costing by Mellon Co.Comparing Absorption andVariable CostingLet’s compare the methods.Reconciling Income Under Absorption and Variable Costing We can reconcile the difference between absorption and variable net income as follows:Fixed mfg. overhead $150,000 Units produced 25,000 = $6.00 per unit =Cost-Volume-Profit AnalysisCVP includes all fixed costs to compute breakeven. Variable costing and CVP are consistent as both treat fixed costs as a lump sum.Absorption costing defers fixed costs into inventory.Absorption costing is inconsistent with CVP because absorption costing treats fixed costs on a per unit basis.AdvantagesManagement finds it easy to understand.Consistent withCVP analysis.Emphasizes contribution in short-run pricing decisions.Profit for period notaffected by changesin fixed mfg. overhead.Impact of fixedcosts on profitsemphasized.Evaluation of Variable CostingAdvantagesConsistent with long-runpricing decisions that mustcover full cost.External reportingand income tax lawrequire absorption costing.Evaluation of Absorption CostingFixed manufacturing overhead istreated the same as the other productcosts, direct material and direct labor.Impact of JIT Inventory MethodsIn a JIT inventory system . . .Production tendsto equal sales . . .So, the difference between variable andabsorption income tends to disappear.Throughput CostingProductcostUnit-levelspending fordirect costs.Unit-level costs are incurred every time a unit ofproduct is manufactured and will not be incurredagain until the next unit is manufactured.Throughput CostingExampleIn an automated process direct material may bethe only unit-level cost and so is the only product cost. All other manufacturing costs are expensed as period costs.Incentive to overproduceis reducedAverage unit cost doesnot vary with changesin production levels.AdvantagesThroughput Income StatementSales Revenue $600,000Throughput cost of goods sold (dir. mat.) 150,000Gross Margin $450,000Less: Operating costs Direct labor 100,000 Variable mfg overhead 60,000 Fixed mfg overhead 150,000 Variable sales & admin costs 50,000 Fixed sales & admin costs 125,000Total operating costs 375,000Net Income $ 75,000
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