The Islamic University –Gaza Inventory Costing Dr. Hisham Madi
Variable and Absorption Costing • Variable costing—a method of inventory costing in which all variable manufacturing costs (direct and indirect) are included as inventoriable costs. (Also known as direct costing). • variable costing is a less-than-perfect term describe this inventory-costing method, because only variable manufacturing costs are inventoried; variable nonmanufacturing costs are still treated as period costs and are expensed
Variable and Absorption Costing • Absorption costing is a method of inventory costing in which all variable manufacturing costs and all fixed manufacturing costs are included as inventoriable costs • inventory “absorbs” all manufacturing costs
Comparing Variable and Absoption Costing • Stassen Company, an optical consumer-productsm manufacturer, its product line is telescopes for aspiring astronomers: • Stassen uses standard costing: • Direct costs are traced to products using standard prices and standard inputs allowed for actual outputs produced. • Indirect (overhead) manufacturing costs are allocated using standard indirect rates times standard inputs allowed for actual outputs produced.
Comparing Variable and Absoption Costing • Stassen’s management wants to prepare an income statement for 2012 (the fiscal year just ended) to evaluate the performance of the telescope product line. The operating information for the year is as follows:
Comparing Variable and Absoption Costing • Actual price and cost data for 2012 are as follows:
Comparing Variable and Absoption Costing • Stassen incurs manufacturing and marketing costs only. The cost driver for all variable manufacturing costs is units produced; the cost driver for variable marketing costs is units sold. • There are no price variances, efficiency variances, or spending variances. • Work- in- process inventory is zero. • Stassen budgeted production of 8,000 units for 2012, budgeted fixed manufacturing cost per unit of $135 ($1,080,000/8,000 units). • Stassen budgeted sales of 6,000 units for 2012, which is the same as the actual sales for 2012 • The actual production for 2012 is 8,000 units. • All variances are written off to cost of goods sold in the period (year) in which they occur.
Comparing Variable and Absoption Costing • Based on the preceding information, Stassen’s inventoriable costs per unit produced in 2012 under the two inventory costing methods are as follows
Variable vs. Absorption Costing: OperatingIncome and Income Statements Comparing Income Statements for One Year • Operating income will differ between absorption and variable costing. • The amount of the difference represents the amount of fixed manufacturing costs capitalized as inventory under absorption costing and expensed as a period cost under variable costing.
Variable vs. Absorption Costing: OperatingIncome and Income Statements • The basis of the difference between variable costing and absorption costing is how fixed manufacturing costs are accounted for
Variable vs. Absorption Costing: OperatingIncome and Income Statements • If inventory levels change, operating income will differ between the two methods because of the difference in accounting for fixed manufacturing costs.
Comparing income statements for multiple years • The $135 fixed manufacturing cost rate is based on the budgeted denominator capacity level of 8,000 units in 2012, 2013, and 2014 ($1,080,000 ÷ 8,000 units = $135 per unit). • Whenever production (the quantity produced, not the quantity sold) deviates from the denominator level, there will be a production-volume variance. • Under variable costing, fixed manufacturing costs of $1,080,000 are always treated as an expense of the period, regardless of the level of production (and sales).
Comparing income statements for multiple years • Why do variable costing and absorption costing usually report different operating income numbers • if inventory increases during an accounting period, less operating income will be reported under variable costing than absorption costing. • Conversely, if inventory decreases, more operating income will be reported under variable costing than absorption costing
Variable Costing and the Effect of Sales and Productionon Operating Income • change in operating income under variable costing is driven solely by changes in the quantity of units actually sold