Quiz 8: Absorption and Variable Costing, and Inventory Management

Business

In Absorption costing, fixed factory overhead is treated as a product cost. Unit product cost consists of direct materials, direct labor, variable factory overhead, and fixed factory overhead. In Variable costing, fixed factory overhead is treated as a period expense. Unit product cost under variable costing consists of direct materials, direct labor, and variable factory overhead. Table showing difference between Absorption costing and Variable costing img

B. greater under absorption costing than variable costing. Formula of ending inventory is given below: img Unit cost in Absorption costing: img img Variable costing unit cost: img img

If a company produces 10,000 units and sells 8,000 units during a period, then absorption costing will result in higher operating income. The difference arises because of the amount of fixed overhead recognized as an expense under the two methods. The cost of goods sold under absorption costing includes some but not all factory overheads. Part of total fixed factory overhead was expensed in cost of goods sold and remaining value is included in the cost of ending inventory. Units coming out of inventory have attached to them fixed overhead from a prior period. In addition, units produced and sold have all of the current period's fixed overhead attached. However, the entire fixed factory overhead is included in the costs for variable costing.