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Absorption and Variable Costing

Absorption Costing Variable Costing

Full Costing Other Names Direct Costing

GAAP Costing Marginal Costing

External Reporting Purpose Internal Reporting

Product Cost Treatment of Fixed FOH Period Cost

Initially inventoried then expensed (FFOH) Fully expensed in the period
as part of CGS when sold incurred regardless if units are
sold or not

FFOH is necessary to produce Reason FFOH is incurred with or without

units production

DM, DL, VFOH, and FFOH Product Cost DM, DL, and VFOH
Higher than VC Lower than AC

Selling and GAE Period Cost FFOH, Selling, and GAE

Lower than AC

Seldom segregates costs into

variable and fixed costs 24
Cost Segregation
Higher than VC

Segregates costs into variable

and fixed costs
20
Compliant Matching Principle Non-compliant
Compliance

Functional (Product vs. Period) Behavioral (Variable vs. Fixed)

CGS Format CM Format

Sales xx Sales xx
h

CGS (xx) Income Statement Format Variable (xx)

GP xx CM xx
tc

OE (xx) Fixed (xx)

Profit xx Profit xx

Profit is influenced by production Profit fluctuates with sales

Ba

Financial Statements CVP Analysis

Reporting to BIR and SEC Uses Pricing Decisions
Relevant Costing

Absorption Costing Profit vs. Variable Costing Profit

Situation Implication Explanation

P=S ACP = VCP End Inv = Beg Inv thus FFOH in AC = FFOH in VC

P>S ACP > VCP End Inv > Beg Inv thus FFOH in AC < FFOH in VC

P<S ACP < VCP End Inv < Beg Inv thus FFOH in AC > FFOH in VC
Where: P - Production; S - Sales; ACP - Absorption Costing Profit; VCP - Variable Costing Profit

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Accounting for Difference in Profit

The difference in profit represents the amount of fixed factory overhead charged to inventory (treated
as asset).

Δ Profit = Δ Inventory x Unit FFOH

Where: Δ Profit = ACP - VCP
Δ Inventory = Ending Inventory - Beginning Inventory / Production - Sales
Unit FFOH = Total FOH ÷ Production / AC Cost per Unit - VC Cost per Unit

Reconciliation of ACP and VCP

Absorption Costing Profit xx
ADD: Fixed FOH in the Beginning Inventory xx
LESS: Fixed FOH in the Ending Inventory (xx)
Variable Costing Profit xx

Problem I
In 2022, UST company’s production was equal to its normal capacity of 1,000 units. It
sold 900 units at a price of P 50 per unit. The following costs were incurred during that
year:

Direct Materials
Direct Labor
Variable FOH
Fixed FOH
P
24
Total Cost
12,000
10,000
8,000
6,000
P
Unit Cost
12
10
8
6
20
Variable Selling & Admin 4,500 5 (4,500 ÷ 900 units sold)
Fixed Selling & Admin 3,000 3
Units Sold 900 units

Determine the following:

1. Product cor per unit under absorption and variable costing.
h

2. Fixed factory overhead per unit.

3. Income under absorption costing.
tc

4. Income under variable costing.

5. Amount of fixed factory overhead charged to inventory.
6. Cost of the ending inventory - absorption.
7. Cost of the ending inventory - variable.
Ba

Problem II
UST produced and sold 12,000 units of a product. Manufacturing and selling costs
incurred were:
Prime Cost P480,000
Variable FOH 108,000
Fixed FOH 24,000
Variable Selling 12,000

1. The product’s unit cost under absorption costing was ______.

2. The product’s unit cost under variable costing was ______.

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Problem III
UST began its operations on January 01, 2022. It produces a single product that sells
for P13.50 per unit. The company uses an actual (historical) cost system. During 2022,
150,000 units were produced and 135,000 units were sold. There was no WIP on
December 31, 2022. The cost data of the company were:
Raw Materials - 3.50 per unit produced
Direct Labor - 2.50 per unit produced
Factory Overhead P195,000 1.00 per unit produced
Selling and Administrative 140,000 1.20 per unit sold

1. What is the profit of UST under absorption costing?

2. What is the profit of UST under variable costing?
3. What is the amount of fixed factory overhead charged to inventory?
4. Prepare a reconciliation of the absorption costing and variable costing profits.
5. The cost of ending inventory under the two costing methods were _____ and ____.

Problem IV
UST’s records for the year 2022 show the following data:

Net Sales
Variable Production Cost
Fixed Production Cost
Variable Operating Expense
24
P21,000
9,450
4,725
1,470
Fixed Operating Expense
Units Sold
Units Produced
2,100
6,000 units
7,000 units
20
There was no beginning and ending WIP inventory. Also, there was no beginning FG
inventory.

1. The ending finished goods inventory under absorption costing is _______.

2. The ending finished goods inventory under variable costing is _______.
3. The profit under absorption costing is _______.
h

4. The profit under variable costing is _______.

tc

Other Product Costing Methods

1. Super Variable Costing (Throughput Costing): treats direct materials as the only
variable cost.
Ba

a. Only direct material costs are inventoried. All other costs are expensed
when incurred.
b. WIP and FG are not recorded.
c. It results in lower income than variable costing when production > sales.
d. It penalizes high production and rewards low production.

Sales xx
Direct Materials (xx)
Throughput Margin xx
Other Expenses (xx)
Profit xx

2. Super Absorption Costing: treats costs from all links in the value chain as
inventoriable costs.

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Problem V
UST sells its products at P120 per unit. It has a material cost per unit of P30 and
conversion cost of P50 per unit. In 2022, it produced 500 units and sold ¾ of the said
production. It also incurred administrative expenses of P2,000.

Determine the following

1. Profit of UST if it uses throughput costing method.
2. Profit of UST if it uses the super absorption costing method.
3. Cost of ending inventory of UST if it uses throughput costing method.
4. Cost of ending inventory of UST if it uses the super absorption costing method.

Multiple-Choice Questions

1. Which of the following is a product cost under absorption costing but not under variable
costing?
a. Variable marketing costs c. Variable manufacturing costs
b. Fixed marketing costs d. Fixed manufacturing costs

2. Under absorption costing, fixed manufacturing overhead costs are best

described as
a. Direct period costs
b. Direct product costs

3. Under variable costing,

24 c. Indirect period costs
d. Indirect product costs
20
a. All period costs are fixed c. All product costs are fixed
b. All period costs are variable d. All product costs are variable

4. As compared to variable costing inventory cost, inventory cost under absorption

costing is typically
a. Lower
h

b. The same c. Higher

d. The same or lower
Items 5 to 7 are based on the following information:
tc

UST manufactures a single product. Unit variable production costs are P 20 and fixed
production costs are P 150,000. UST uses a normal activity of 10,000 units. UST began
the year with no inventory, produced 12,000 units, and sold 7,500 units.
Ba

5. How much is the unit product cost under variable costing?

a. P 20.00 c. P 32.50
b. P 35.00 d. P 40.00

6. How much is the unit product cost under absorption costing?

a. P 20.00 c. P 32.50
b. 35.00 d. P 40.00

7. What is the volume or capacity variance under absorption costing?

NOTE: volume variance = (actual production – normal production) x unit FFOH
a. P 24,000 unfavorable c. P 24,000 favorable
b. P 30,000 unfavorable d. P 30,000 favorable

8. If production is higher than sales, then absorption costing profit is expected to be

a. Lower than variable costing profit
b. Equal to the variable costing profit
c. Higher than variable costing profit
d. Incomparable with variable costing profit

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9. UST produced 10,000 units and sold 9,000 units. Fixed manufacturing overhead
costs were P20,000, and variable manufacturing overhead costs were P 3 per
unit. Which of the following best describes the profit under the absorption
costing method?
a. P 2,000 less than profit under variable costing method
b. P 5,000 less than profit under variable costing method
c. P 2,000 more than profit under variable costing method
d. P 5,000 more than profit under variable costing method

10. If ending inventory is higher than beginning inventory, then absorption costing
profit is expected to be
a. Lower than variable costing profit
b. Equal to the variable costing profit
c. Higher than variable costing profit
d. Incomparable with variable costing profit

11. UST has an operating income of P 50,000 under direct costing. Beginning and
ending inventories were 13,000 units and 18,000 units, respectively. If the fixed
factory overhead application rate is P 2 per unit, then what is the operating
income under the absorption costing?
a. P 70,000 c. P 60,000
b. P 50,000

24 d. P 40,000

12. UST had 16,000 units in its beginning inventory. The company’s variable
production costs were P 6 per unit and its fixed manufacturing overhead costs
were P 4 per unit. The company’s net income for the year was P 24,000 lower
20
under absorption costing than it was under variable costing. How many units
does the company have in its ending inventory?
a. 22,000 units c. 10,000 units
b. 6,000 units d. 4,000 units

13. UST had a net income of P 90,000 using variable costing and net income of P
h

85,500 using absorption costing. Total fixed manufacturing overhead cost was P
150,000 and production was 100,000 units. How did the inventory level change
tc

during the year?

a. 3,000 units increase c. 3,000 units decrease
b. 500 units increase d. 4,500 units decrease
Ba

14. Variable costing profit fluctuates with (A) ____ and does not react to changes in
(B) ____.
a. (A) sales (B) production c. (A) production (B) sales
b. (A) sales (B) demand d. (A) production (B) supply

15. Variable costing is unacceptable for

a. Financial reporting d. Short-term decision making
b. Transfer pricing
c. CVP analysis

References:
1. Roque, R. S. Reviewer in Management Advisory Services (2016). GIC Enterprises & Co., Inc.
2. Review Materials from Review School of Accountancy

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