In: Accounting
please select a product that you can use and list some of the manufacturing costs (direct material, direct labor, variable factory overhead, and fixed factory overhead). Indicate which would be included in the cost of goods sold under variable and absorption costing.
Absorption costing, also called full costing, is what you are used to under Generally Accepted Accounting Principles. Under absorption costing, companies treat all manufacturing costs, including both fixed and variable manufacturing costs, as product costs. Remember, total variable costs change proportionately with changes in total activity, while fixed costs do not change as activity levels change. These variable manufacturing costs are usually made up of direct materials, variable manufacturing overhead, and direct labor. The product costs (or cost of goods sold) would include direct materials, direct labor and overhead. The period costs would include selling, general and administrative costs.
The following diagram explains the cost flow for product and period costs.
The product cost, under absorption costing, would be calculated as:
Direct Materials |
+ Direct Labor |
+ Variable Overhead |
+ Fixed Overhead |
= Total Product Cost |
You can calculate a cost per unit by taking the total product costs / total units PRODUCED. Yes, you will calculate a fixed overhead cost per unit as well even though we know fixed costs do not change in total but they do change per unit. We will assign a cost per unit for accounting reasons. When we prepare the income statement, we will use the multi-step income statement format.
We will not get as complicated in our multi-step income statement as the video example but it should have provided a refresher from what you should have learning in financial accounting. For our purpose, the absorption income statement will contain:
Sales |
– Cost of Goods Sold |
= Gross Profit |
Operating Expenses: |
Selling Expenses |
+ General and Admin. Expenses |
= Total Expenses |
= Net Operating Income |
Gross Profit is also referred to as gross margin. Net operating income is Gross Profit – Total Operating Expenses and is also called Income before taxes.