Question

How is fixed overhead presented in product costing and period costing. How does this relate to the Net Income for each?

Answer 1

Fixed manufacturing overheads are part of product cost in Absorption costing. Hence the closing stock in Absorption costing gets valued at full product cost. In Period cost the fixed manufacturing overheads is charged to the period in which it is incurred and hence closing stock in Variable costing gets valued at variable manufacturing cost only.

Treatment of fixed manufacturing overheads as product cost or period cost impacts the net profit reported for the period. When fixed manufacturing overhead is treated as product cost the closing inventory of finished goods during the period will increase the net income reported in Income statement. If Opening inventory is higher than closing inventory the profit reported under Absorption costing will be lower compared to variable costing. When fixed manufacturing overheads is treated as period cost in Variable costing it is charged to the period in which it is incurred and hence difference of fixed manufacturing overheads absorbed in product cost will be the difference in net income reported under Variable costing compared to Absorption costing.