Question

When a company produces more inventory than it sells to customers, would the absorption costing income statement profits or the variable costing income statements profits be higher for the period?

Explain why (200 words minimum)

Answer 1

Absorption Costing - In this costing Prime Cost i.e Direct Labor, Direct Material , Direct Expenses & Variable Overhead , Fixed Manufacturing overhead included in the cost of Inventory. If there is opening balance of Inventory in the current fiscal year then last year fixed cost also included in the current Income Statement.

Variable Costing - Under this costing only current year fixed cost taken in the income statment and in inventory only direct cost is included because fixed cost is period cost and it is directly debited in the Income statement of current period.

So if there is higher production than units sells to customers then Absorption Costing profit is higher than variable costing because there is some amount of Fixed Manufacturing overhead not debited in the Income statement and it is showing in the closing inventory account. But if there is low production then sells to cusomer then Variable Costing profit is higher than Absorption costing. Because last year and current period cost is debited in the income statement in Cost of good sold.