Question

In: Accounting

locate a journal article about absorption and/or variable costing. In the subject line of your post,...

locate a journal article about absorption and/or variable costing. In the subject line of your post, include the name of the article that you read. Post a link to that article with your initial post, and provide a summary and a reaction to the article. The summary should be approximately 250 words, and the reaction should be approximately 150 words. The summary should describe the major points of the article, and the reaction should demonstrate your interpretation of the article and how you can apply that knowledge.

Solutions

Expert Solution

Absorption and variable costing (Understanding of methods of costing,Comparison and contrast)

Absorption Costing -

  • Absorption costing refers to allocation of all the costs (fixed expenses+variable expenses) to products. Absorbtion costing is also termed as full costing or total costing.
  • The value of product/inventroy under absorption costing comprises of all costs - direct materials, direct labours, all overheads.
  • Absorption cost "absorbs'' all the costs to the inventory including the fixed cost, we can also conclude that it is in accordance to the standards of accoounting. The standards suggests that - 'all the cost relating to inventory (whether it is fixed or variable) should be charged in computing in cost the inventory'. Similarily, the absorption costing also suggest allocation of all the expense incurred with respect to the product should be charged to the product.
  • Cost-volume-profit analysis is difficult in case of absorption costing.
  • Under Absorption costing cost per unit of product decreases as the production level increase, for the same level of production the cost per unit remains same.
  • Example - Suppose ABC manufactures Product X. fixed cost is 1000 and variable is 5/- per unit. Lets take following production scenarios -

(i) Production is 100 units. Then cost per unit would be = (1000/100)+5 = 15/-

(ii) Production is 50 units. Then cost per unit would be = (1000/50)+5 = 25/-

(iii) Production is 200 units. Then cost per unit would be = (1000/200)+5 = 10/-

So, as the production level is increased, fixed cost is absorbed with higher quantities that results in reduction in per unit cost of the product.

Variable Costing

  • As the name itself conveys its properties, variable costing refers to llocation of only variable costs to the Product ignoring the fixed manufacturing expenses incurred with respect to the product.
  • Variable costing is inconsistent with GAAP and accounting principle and is not considered in Financial Reporting as this approach does not suggests allocation of total cost to the Product.
  • In variable costing the per unit cost of the product remains same at every level of production. Increase or decrease in level of production does not effect per unit cost of product.
  • Variable costs includes all the direct costs -

(i) Direct Materails,  

(ii) Direct Labour,  

(iii)  Variable Manufacturing Overheads.

  • The management can compute marginal contribution by subtracting variable costs from the selling value of the product. In simple words Marginal Contribution = Sale value - Variable Costs.
  • Cost-volume-profit analysis can be easily computied in case of variable costing.

Table :- Costs considered in allocation to products in Absorption and Variable Costing

Costs Absorption Costing Variable Costing
Direct Material Considered Considered
Direct Labour Considered Considered
Variable manufacturing overhead Considered Considered
Fixed Manufacturing Overhead Considered Not Considered

Reconciliation of Income under both the methods can be done in following way -

Income under Variable Costing XXX
+Fixed Manufacturing Overhead (beginning & end of inventory) XXX
Income under Absorption Costing XXX

So we can conclude that -

Both the methods of costing are equal important and have respective purpose, use,advantages and disadvantages. The management should use these methods according to their use and reports they want to prepare

The Managers should used variable costing as these reports are easier to understand because overhead changes with cost drivers.

Managers can use variable costing for the purpose of CVP analysis.

The impact of Fixed cost can be analysed and its impact can be easily seen. The Management can analyse the impact of direct and variable cost on the value of inventory and calculate Marginal contribution Reports.

However, variable costing is not acceptable for Financial Reporting. Absorption costing are considered as more useful and consistent with Financial Reporting, GAAPs. In Financial Reports all the costs related to the product are charged to the product. This requires reconciliation of Profits.

For tax reporting purpose also, absorption costing is used instead of variable costing approach.

Absorption Costing is not useful for making managerial decisions as cost of product per unit changes with change in production level. According to this method, cost would be less where production quanting increases. However, this may not be profitable for the company all the time.

Absorption costing is not very used for cost reduction strategies and implementing cost control.

For startups, absorption costing may not prove to the best method for computing the costs in long run as level of product is very low and per unit cost as per absorption costing will be high (as it includes fixed expenses also). For startup fixed costs would be recovered in long run, what actually matters is the variable cost to find the profitablity of the unit.

Absorption costing is useful for the the manufacturing units having single products.

The profits calculated in Absorption costing provides insight into the recovery of all the expenses (Fixed +variable) over the selling price. That is if a company is in profit, that means the entity is able to recover all the costs from its selling price. And it calculates the correct profit because both costs variable and fixed are actually incurred.

Absorption costing helps the managers to recognise fixed expense department wise/unit wise as the fixed costs are absorbed on the basis of product/department/unit. Hence, the managers can analyse the scope of reduction in fixed cost in a particular area/department/unit.

So, both the methods are being used in real world. Both the methods are useful to the management with their advantages and limitations. It depends on the management what kind of report it need and according the methods of costing should be deployed. Ex - If management wants to analyis its direct cost, it should go for variable costing and if it wants to compute the overall profit absorption costing should be used.


Related Solutions

absorption and/or variable costing. In the subject line of your post, include the name of the...
absorption and/or variable costing. In the subject line of your post, include the name of the article that you read. Post a link to that article with your initial post, and provide a summary and a reaction to the article. The summary should be approximately 250 words, and the reaction should be approximately 150 words. The summary should describe the major points of the article, and the reaction should demonstrate your interpretation of the article and how you can apply...
Find a journal article online about job costing systems. In the subject line of your post,...
Find a journal article online about job costing systems. In the subject line of your post, include the title of the article that you read. Post a link to that article with your initial post, and provide a summary and a reaction to the article. The summary should be approximately 250 words, and the reaction should be approximately 150 words. The summary should describe the major points of the article, and the reaction should demonstrate your interpretation of the article...
Using the Library locate a journal article about responsibility accounting. In the subject line of your...
Using the Library locate a journal article about responsibility accounting. In the subject line of your post, include the name of the article that you read. Post a link to that article with your initial post, and provide a summary and a reaction to the article. The summary should be approximately 250 words, and the reaction should be approximately 150 words. The summary should describe the major points of the article, and the reaction should demonstrate your interpretation of the...
Using the GCU Library locate a journal article about responsibility accounting. In the subject line of...
Using the GCU Library locate a journal article about responsibility accounting. In the subject line of your post, include the name of the article that you read. Post a link to that article with your initial post, and provide a summary and a reaction to the article. The summary should be approximately 250 words, and the reaction should be approximately 150 words. The summary should describe the major points of the article, and the reaction should demonstrate your interpretation of...
Responsibility accounting. In the subject line of your post, include the name of the article that...
Responsibility accounting. In the subject line of your post, include the name of the article that you read. Post a link to that article with your initial post, and provide a summary and a reaction to the article. The summary should be approximately 250 words, and the reaction should be approximately 150 words. The summary should describe the major points of the article, and the reaction should demonstrate your interpretation of the article and how you can apply that knowledge.
Your assignment this week is to locate a relevant, appropriate journal article for your critique. The...
Your assignment this week is to locate a relevant, appropriate journal article for your critique. The journal article critique focuses on peer-reviewed, empirical journal articles. Your journal article critique must focus on one of the theories of personality covered in this course (I encourage you to browse ahead in the course to overview all the various theories of personality that we will cover). Utilize the UMUC library (www.umuc.edu) to locate a peer-reviewed, empirical journal article; you must select an article...
Absorption and variable costing:
The Dorset Corporation produces and sells a single product. The following data refer to the year just completed:Beginning inventory 0Units produced 9,000Units sold 7,000Selling price per unit $ 47Selling and administrative expenses:Variable per unit $ 4Fixed per year $ 58,000Manufacturing costs:Direct materials cost per unit $ 10Direct labor cost per unit $ 6Variable manufacturing overhead cost per unit $ 5Fixed manufacturing overhead per year $ 90,000Assume that direct labor is a variable cost.Required:a. Prepare an income statement for the year...
Post your article about Business and the Environment Post your article here and include the following...
Post your article about Business and the Environment Post your article here and include the following information in your post: 1. What is the article about? 2. What did you learn?
Two observations can be made about variable and absorption costing. First, a variable costing income statement...
Two observations can be made about variable and absorption costing. First, a variable costing income statement classifies cost based on behavior, variable or fixed. An absorption costing income statement classifies cost based on nature (use in manufacturing or selling and administration, etc.). Second, in variable costing income statements, fixed manufacturing costs are excluded from inventoriable costs. In absorption costing income statements, fixed manufacturing costs are included in inventoriable costs. Many large companies prepare both kinds of income statements. For what...
Two observations can be made about variable and absorption costing. First, a variable costing income statement...
Two observations can be made about variable and absorption costing. First, a variable costing income statement classifies cost based on behavior. An absorption costing income statement classifies cost based on character or nature (manufacturing, selling, administrative). Second, in variable costing income statements… fixed manufacturing costs are excluded from inventoriable costs. In absorption costing income statements… fixed manufacturing costs are included in inventoriable costs. Many large companies prepare both kinds of income statements. For what purpose?
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT