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Absorption Costing (AC) & Variable Costing (VC)

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Absorption Costing (AC) & Variable Costing (VC). Differences between AC and VC Calculation of Product Cost under AC and VC VC and AC : A comparison of their impact on profit Arguments in support of VC Arguments in support of AC. Differences between AC and VC. Absorption Costing

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absorption costing ac variable costing vc

Absorption Costing (AC) &Variable Costing (VC)

Differences between AC and VC

Calculation of Product Cost under AC and VC

VC and AC : A comparison of their impact on profit

Arguments in support of VC

Arguments in support of AC

differences between ac and vc
Differences between AC and VC
  • Absorption Costing
  • Assign all manufacturing costs to products
  • Non manufacturing cost treated as period cost i.e excluded from inventory valuation
  • Allowed for external reporting
  • Variable costing
  • Only variable manufacturing costs are assigned to products and included in inventory valuation
  • Fixed manufacturing costs are not assigned to products
  • Only for internal reporting
calculation of product cost
Calculation of Product Cost
  • Under AC
  • Product Cost
    • Direct Material costs
    • Direct Labour costs
    • Variable Overhead Manufacturing costs
    • Allocated Fixed Manufacturing Overhead
calculation of product cost1
Calculation of Product Cost
  • Under VC
  • Product Cost
    • Direct Material costs
    • Direct Labour costs
    • Variable Overhead Manufacturing costs
vc and ac a comparison of their impact on profit
VC and AC : A comparison of their impact on profit
  • Production equals sales
    • AC profit equals VC profits
  • Production exceeds sales
    • AC profit greater than VC profit
  • Sales exceeds production
    • VC profit greater than AC profit
absorption costing
LO 2ABSORPTION COSTING

Value of ending inventory =

2,000 x RM 225 = RM 450,000

variable costing
LO 2VARIABLE COSTING

Value of ending inventory =

2,000 x $ 200 = $ 400,000

comparative income statements
LO 2COMPARATIVE INCOME STATEMENTS

Income lower under variable costing where fixed costs are expensed for period.

absorption income statement
LO 2ABSORPTION INCOME STATEMENT

COGS =

8,000 x $ 225 = $ 1,800,000

variable income statement
LO 2VARIABLE INCOME STATEMENT

Variable costs: 8,000 x $200

Fixes costs: $250,000 + 100,000

absorption vs variable
LO 2ABSORPTION VS. VARIABLE

If more is sold than produced, variable costing income > absorption-costing income, opposite of Fairchild situation. Equal production & sales means equal income.

slide13
How do variable & absorption costing affect performance evaluation?

Variable costing ensures that direct relationship between sales & income holds whereas absorption costing does not.

explanation
LO 2EXPLANATION

The difference between variable costing & absorption costing year to year is equal to the change in fixed overhead.

Under absorption costing, fixed overhead is assigned to inventory produced.

Under variable costing, fixed overhead is a period expense.

some arguments in support of variable costing
Some arguments in support of Variable Costing
  • VC provides more useful information for decision making
  • VC removes from profit the effect of inventory changes
  • VC avoids fixed overhead being capitalised in unsaleable stocks
some arguments in support of absorption costing
Some arguments in support of Absorption Costing
  • AC does not understate the importance of Fixed costs
  • AC avoids fictitious losses being reported
  • Fixed overhead are essential for production
  • Consistency with external reporting
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