Variable Costing

Kuiz – 16/3/08

1.

a Under absorption costing, all manufacturing costs (variable and fixed) are included in product costs.

		$
	Direct materials.........................................................	7.00
	Direct labor..............................................................	6.00
	Variable manufacturing overhead................................	3.00
	Fixed manufacturing overhead ($160,000 ÷ 40,000 units)....................................................................	4.00
	Unit product cost......................................................	$20.00

Ending inventory (5,000 units x $20) ..................... $100,000

b. Under variable costing, only the variable manufacturing costs are included in product costs.

		$
	Direct materials......................................................	7.00
	Direct labor............................................................	6.00
	Variable manufacturing overhead.............................	3.00
	Unit product cost....................................................	$16.00

Ending inventory (5,000 units x $16) ..................... $80,000

Note that selling and administrative expenses are not treated as product costs under either absorption or variable costing; that is, they are not included in the costs that are inventoried. These expenses are always treated as period costs and are charged against the current period’s revenue.

c. Absorption costing would show the highest net income, by $20,000.The reason is that the incventory has increased by 5,000 units, and each unit has taken $4 of fixed manufacturing overhead cost into inventory with it. This removes these costs from the income statements.