Question

What is variable cost? Identify two variable costs.

When units produced exceed units sold for a reporting period, would income under variable costing be greater than,equal to, or less than income under absorption costing? Explain.

Answer 1

Question 1

Variable Costs are the costs which have a direct relationship with their usage level which means the cost increases with the increase in their usage level and similarly decreases with a decrease in their usage level. In short Variable Costs are those costs which directly tends to chane with their usage fixed level. They are andnit fixed in nature and varies with the changes in the activity usage level.They directly varies according to the Production or Procurement level.

Examples of Two Variable Costs are as follows:-

1. Direct Materials Cost.

2. Direct Labour Cost.

Question 2

When the units produced exceeds the unit sild then Variable Costing Operating Income will be less than that of the Absorption Costing Operating Income because of the reason that Variable Costing treats Fixed Manufacturing Overheads as period costs which means they are expensed out in the period of their incurrence whereas Absorption Costing Income Statement treats Fixed Manufacturing Costs as a part of Unit Product Cost due to which the whole cost gets Allocated over the number of units Produced and if the units sold are less than that of actually Produced then the cost Allocated on unuts in Ending Inventory gets deferred for future period and absorption costing income is more than that of variable costing Income. The following example will help the case better.

ABC Company

Units Produced - 50,000

Units sold - 40,000

Sales Price per Unit = $ 50

Direct Materials Cost per Unit = $ 9

Direct Labour Cost = $ 6

Variable Manufacturing Overhead = $ 5

Fixed Manufacturing Overhead = $ 100,000 per Year

Selling and Administrative Expenses = $ 200,000 per Year

Unit Product Cost as per Variable Costing = Direct Materials Cost per Unit + Direct Labour Cost per Unit + Variable Manufacturing Overhead per Unit

= 9 + 6 + 5 = $ 20

Unit Product Cost as per Absorption Costing = Direct Labour Cost per Unit + Direct Materials Cost per Unit + Variable Manufacturing Overhead per Unit + Fixed Manufacturing Overheads per Unit

= 9 + 6 + 5 + 2 = $ 22

Particulars	Absorption	Variable
Sales Revenue	20,00,000	20,00,000
Less: Cost of Goods Sold	8,80,000	8,00,000
Less: Fixed Manufacturing Overhead	0	1,00,000
Gross Profit / Contribution Margin	11,20,000	11,00,000
Less: Selling and Administrative Expenses	200,000	200,000
Net Income / (Loss)	920,000	900,000

Sales = 40,000 * $ 50 per Unit = $ 20,00,000

Cost of Goods Sold = Units Sold * Unit Product Cost

Variable Costing = 40,000 Units * $ 20 per Unit = $ 800,000

Absorption costing = 40,000 Units * $ 22 per Unit = $ 880,000