MAC 302 – MANAGEMENT REPORTING
2nd Semester, AY 2024 – 2025
BS Management Accounting
Module 3
VARIABLE COSTING AND ABSORPTION COSTING
Learning Objectives:
a. Differentiate Management Accounting to Cost System
b. Classify and define different costs and cost classifications
THE VARIABLE COSTING
It is a product costing method that includes only the variable costs the manufacturing costs (direct materials, direct labor,
and variable overhead) in the cost of a unit of product. Under the variable costing method, fixed factory overhead is
treated as a period cost. Variable costing is premised on the philosophy that costs are either fixed or variable. Variable
costs relate to units sold.
Sales xx
Less: Variable Costs and Expenses (xx)
Contribution Margin xx
Less: Fixed Cost and Expenses (xx)
Profit xx
THE ABSORPTION COSTING
a product costing method that includes all the manufacturing costs (direct materials, direct labor, and both the variable
and fixed factory overhead) in the cost of a unit of product. ➢Under the absorption costing method, fixed factory
overhead is treated as a product cost.
Absorption costing operates within the framework of the International Financial Reporting. It is also known as "full costing’
or "traditional costing”. It classifies costs and the accrual expenses according to the functional nature of business
operations such as cost of goods yin in sold, marketing, selling, and administrative expenses.
Reference: Management Services (2021 Edition )by: Franklin T. Agamata
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MAC 302 – MANAGEMENT REPORTING
2nd Semester, AY 2024 – 2025
BS Management Accounting
The difference between absorption and variable costing methods
The difference between absorption and variable costing methods lies on how the fixed overhead is treated. Under the
absorption costing fixed overhead is treated as a product cost while under the variable costing fixed overhead is treated as
a period cost. The matrix below shows how costs and expenses are classified under absorption and variable costing
systems.
DIFFERENCE IN NET INCOME UNDER ABSORPTION AND VARIABLE COSTING
Variable and absorption costing methods of 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 fixed 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.
RECONCILIATION OF ABSORPTION AND VARIABLE COSTING INCOME FIGURES
Absorption costing income xx
Add Fixed overhead in the beginning inventory xx
Total xx
Less Fixed overhead in the ending inventory xx
Variable costing income xx
ACCOUNTING FOR DIFFERENCE IN INCOME
Change in inventory (Production less Sales) xx
x Fixed FOH cost per unit xx
Difference in income xx
Reference: Management Services (2021 Edition )by: Franklin T. Agamata
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MAC 302 – MANAGEMENT REPORTING
2nd Semester, AY 2024 – 2025
BS Management Accounting
Understanding the profit behavior under the absorption and variable costing systems
Sample Problem 1:
Sample Problem 2:
Volume variance represents the ability of the business to meet its normal capacity. Volume variance is related to fixed
overhead which is constant per total. In short, fixed overhead is not controlled on its total amount but is controlled in
relation to volume (i.e., production).
The Normal Capacity
Reference: Management Services (2021 Edition )by: Franklin T. Agamata
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MAC 302 – MANAGEMENT REPORTING
2nd Semester, AY 2024 – 2025
BS Management Accounting
Normal capacity refers to the average production level of the business over a long range of time or over the period
covered in the budget. It is influenced, one way or another, by plant capacity, engineering design, market size, budgetary
capability, legal restrictions, cultural orientations and other variables.
Sample Problem 3
Hunter X Hunter Corporation has the following standard costs and production data in 20CY:
Reference: Management Services (2021 Edition )by: Franklin T. Agamata
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MAC 302 – MANAGEMENT REPORTING
2nd Semester, AY 2024 – 2025
BS Management Accounting
MULTIPLE CHOICES
1. Under the direct costing, which is classified as product costs?
a. Only variable production costs.
b. Only direct costs.
c. All variable costs.
d. All variable and fixed production cost.
2. Which of the following is an argument against the use of direct (variable) costing?
a. Absorption costing overstates the balance sheet value of inventories.
b. Variable factory overhead is a period cost.
c. Fixed factory overhead is difficult to allocate properly.
d. Fixed factory overhead is necessary for the production of a product.
3. A basic tenet of variable costing is that fixed overhead costs should be currently expensed. What is the rationale
behind this procedure?
a. Period costs are uncontrollable and should not be charged to a specific product.
b. Period costs are generally immaterial in amount and the cost of assigning the amounts to specific products
would outweigh the benefits.
c. Allocation of period costs is arbitrary at best and could lead to erroneous decisions by management.
d. Because period costs will occur whether or not production occurs, it is improper to allocate these costs to
production and defer a current cost of doing business.
4. In an income statement prepared as an internal report using the direct (variable) costing method, fixed selling and
administrative expenses would
a. Not be used.
b. Be used in the computation of the contribution margin.
c. Be used in the computation of operating income but not in the computation of the contribution margin.
d. Be treated the same as variable selling and administrative expense.
5. If sales equals production, one would expect net income under the variable costing method to be
a. The same as net income under the absorption costing method.
b. Greater than net income under the absorption costing method.
c. Differing in as much as the difference between sales and production.
d. Less than net income under the absorption costing method.
6. If production is greater than sales (units), then absorption costing net income will generally be
a. greater than direct costing net income.
b. less than direct costing net income.
c. equal to direct costing net income.
d. additional data is needed to be able to answer.
7. Which one of the following statement is correct regarding absorption costing and variable costing?
a. Overhead costs are treated in the same manner under both costing methods.
b. If finished goods inventory increases, absorption costing results in higher income.
c. Variable manufacturing costs are lower under variable costing.
d. Gross margins are the same under both costing methods.
8. A cost that would be included in product costs under both absorption costing and variable costing would be:
a. supervisory salaries.
b. equipment depreciation.
c. variable manufacturing costs.
d. variable selling expenses
9. In absorption costing, a as contrasted with direct costing, the following are abnorned into inventory.
a. All the elements of [Link] variable manufacturing overhead.
Reference: Management Services (2021 Edition )by: Franklin T. Agamata
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MAC 302 – MANAGEMENT REPORTING
2nd Semester, AY 2024 – 2025
BS Management Accounting
b. Only the fixed manufacturing overhead.
c. Only the variable manufacturing overhead.
d. Neither fixed nor variable manufacturing overhead.
10. On the variable costing income statement, the difference between the "contribution margin" and "income before
income tax" is equal to
a. the total operating expenses
b. the total fixed costs
c. fixed selling and administrative expenses
d. the total variable costs
EXERCISES
1. Northern Bicycle produces an inexpensive motorbike that sell$ for P12,000. Selected data for the company’s
operations last year follow:
Units in beginning inventory 300
Units produced 1,000
Units sold 800
Units in ending inventory 500
Variable costs per unit:
Direct materials 1,300
Direct labor 800
Manufacturing overhead 500
Selling and administrative 200
Fixed costs per year:
Manufacturing overhead P4,000,000
Selling and administrative 2,000,000
Required:
a. Compute the unit costs under absorption and variable costing methods.
b. Compute the operating income under absorption and variable costing methods.
c. Compute the value of ending inventory under absorption and variable costing methods.
d. Reconcile the difference in operating income under the absorption and variable costing methods.
2. Lina Company produced 100,000 units of Product Zee during the month of June. Costs ‘incurred during June were
as follows:
Direct materials P 100,000
Direct labor 80,000
Variable manufacturing overhead 40,000
Fixed manufacturing overhead 50,000
Variable selling and general expenses 12,000
Fixed selling and general expenses 46,000
P327,000
a. What was product Zee's unit cost under absorption costing?
b. What was product Zee's unit cost under variable (direct) costing?
3. Don Papot Ltd., manufactures a single product for which the costs and selling prices are:
Variable production costs P 50 per unit
Selling price P 150 per unit
Fixed production costs P 200,000 per quarter
Fixed selling and administrative
Overhead P 480,000 per quarter
Normal capacity is 20,000 units per quarter. Production in 1 quarter was 19,000 per units and sales volume was 16,000
units. No opening inventory for the quarter. What is the absorption costing profit for the quarter?
Reference: Management Services (2021 Edition )by: Franklin T. Agamata
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MAC 302 – MANAGEMENT REPORTING
2nd Semester, AY 2024 – 2025
BS Management Accounting
4. Last year, Risa Company had income of 60,000 using variable costing. Beginning and ending inventories were
33,000 and 38,000 units, respectively. If the fixed manufacturing overhead cost was P2.00 per unit. What was the
income under absorption costing?
5. Variable Production costs are P8 per unit, variable selling and administrative expenses are P4 per unit. Fixed MOH
totals P50,000 and fixed selling total P30,000. Assuming beginning inventory of zero, production of 5,000 units
and sales of 4,600 units, the peso value of the inventory end of variable costing would be?
Reference: Management Services (2021 Edition )by: Franklin T. Agamata
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