Variable and Absorption COsting

• Variable Costing


  System that determines which manufacturing costs are treated as inventoriable costs
• Absorption Costing

  • All variable and fixed manufacturing costs are included as inventoriable costs
  • Inventory ‘absorbs’ ALL manufacturing costs
• Throughout Costing

  • Only direct materials are captalized while all other costs are expensed
  • The difference represents the amount of fixed manufacturing costs capitalized as inventory under absorption costing and expensed as a period cost under variable costing
  • If inventory levels change, operating income will differ because of the difference in accounting for fixed manufacturing costs
• CAPACITY LEVELS

  ★ Theoretical capacity

  ★ Practical capacity

  ★ Normal capacity utilization

  ★ Master-budget capacity utilization
• DENOMINATOR LEVEL CAPACITY


  Spending on fixed manufacturing costs enables firms to obtain the scale or capacity needed to satisfy the expected market demand

  Too much capacity = cost of unused capacity

  Too little capacity = demand from

  some customers may be unfulfilled
• 1. Theoretical Capacity (Optimistic)

  ★ Level of capacity based on producing at full efficiency all the time

  ★ Does not allow any slowdowns

  ★ Realistically, is unattainable since its

  the ideal goal of capacity utilization
• Practical Capacity (Realistic)

  ★ Level of capacity that reduces theoretical capacity by considering unavoidable interruptions (maintenance and holidays)
• Normal Capacity Utilization

  ★ Level of capacity that satisfies average customer demand over a period long enough to consider seasonal, cyclical, and trend factors
• Master-Budget Capacity Utilization

  ★ Level of capacity that managers expect for the current budget period (usually 1 year)
• Cost Information


  Vital information to determine how much a product or service costs them
• Absorption Costing


  In conformity with GAAP

  For external Users
• Variable Costing


  Not in conformity with GAAP

  For Internal Users as it helps management to identify factors affecting production cost