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
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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: Operating
Income 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: Operating
Income and Income Statements
Variable vs. Absorption Costing: Operating
Income 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: Operating
Income 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
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
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
Comparing income statements for
multiple years
Comparing income statements for
multiple years
Variable Costing and the Effect of Sales and Production
on Operating Income
 change in operating income under variable costing is
driven solely by changes in the quantity of units
actually sold