Question

1. Xylo produces xylophones. Each xylophone is sold for $850. Selected data for the company’s operations last year follow:

Units in beginning inventory                                      0

Units Produced                                                           250

Units Sold                                                                   225

Units in ending inventory                                           25

Variable Costs per unit:

            Direct materials                                              $100

            Direct labor                                                     $320

            Variable Mfg Overhead                                  $40

            Variable Selling & Admin                              $20

Fixed Costs:

            Fixed Mfg Overhead                                       $60,000

            Fixed Selling & Admin                                  $20,000

Required:

1. Compute the unit product cost for one xylophone under absorption costing.
2. Compute the unit product cost for one xylophone under variable costing.

Answer 1

Computation of Unit Product Cost Under Absorption Costing
Particulars
Number Of Units Produced (a)	250
Direct Material (b)	100
Direct Labour Per unit (c )	320
Variable Mfg Overhead (d)	40
Variable Selling and Administration (e)	20
Fixed Mfg Overhead (f= 60,000/a)	240
Fixed Selling and Administation (g=20,000/a)	80
Total unit product cost (b+c+d+e+f+g)	800

Computation of Unit Product Cost Under Variable Costing
Particulars
Number Of Units Produced (a)	250
Direct Material (b)	100
Direct Labour Per unit (c )	320
Variable Mfg Overhead (d)	40
Variable Selling and Administration (e)	20
Total unit product cost (b+c+d+e)	480

Absorption Costing

accounting principles require use of absorption costing (also known as “full costing”) for external reporting. Under absorption costing, normal manufacturing costs are considered product costs and included in inventory.

Absorption Costing LogicAs sales occur, the cost of inventory is transferred to cost of goods sold, meaning that the gross profit is reduced by all costs of manufacturing, whether those costs relate to direct materials, direct labor, variable manufacturing overhead, or fixed manufacturing overhead. Selling, general, and administrative costs (SG&A) are classified as period expenses.

The rationale for absorption costing is that it causes a product to be measured and reported at its complete cost. Because costs like fixed manufacturing overhead are difficult to identify with a particular unit of output does not mean that they were not a cost of that output. As a result, such costs are allocated to products. However valid the claims are in support of absorption costing, the method does suffer from some deficiencies as it relates to enabling sound management decisions. Absorption costing information may not always provide the best signals about how to price a product, reach conclusions about discontinuing a product, and so forth

Variable Costing

Variable Costing LogicTo allow for deficiencies in absorption costing data, strategic finance professionals will often generate supplemental data based on variable costing techniques. As its name suggests, only variable production costs are assigned to inventory and cost of goods sold. These costs generally consist of direct materials, direct labor, and variable manufacturing overhead. Fixed manufacturing costs are regarded as period expenses along with SG&A costs. In some ways, this understates the true cost of production. How then can it aid in decision making? The short answer is that the fixed manufacturing overhead is going to be incurred no matter how much is produced. In the long run, a business must recover those costs to survive. But, on a case-by-case basis, including fixed manufacturing overhead in a product cost analysis can result in some very wrong decisions