The difference in net income reported under direct costing versus the net income reported under absorption costing is calculated based on the change in the inventory levels times the unit fixed manufacturing overhead cost.

Question

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Under direct (variable) costing, only variable manufacturing costs are included in product costs, while fixed manufacturing overhead is expensed in the period incurred. Under absorption costing, both variable and fixed manufacturing overhead costs are included in product costs. Therefore, when inventory levels increase, absorption costing allocates more fixed costs to inventory, reducing the expense recognized in the current period and increasing net income compared to direct costing. Conversely, if inventory levels decrease, more fixed costs are recognized as expense under absorption costing, reducing net income compared to direct costing. The difference in net income between the two methods is indeed the change in inventory levels multiplied by the fixed manufacturing overhead cost per unit.

The Difference in Net Income Reported Under Direct Costing Versus