Chapter 19 - Objectives

1. Describe and illustrate income

reporting under variable costing
and absorption costing.
2. Describe and illustrate income
analysis under variable costing
and absorption costing.
 Two Costing Methods

Absorption Costing
 Used for external financial
reporting
 Includes direct materials, direct
labor, variable factory overhead,
and fixed factory overhead as
part of total product cost
 Two Costing Methods

Variable Costing
 Used for internal planning
and decision making
 Does not include fixed factory
overhead as a product cost
Absorption Costing Compared to
Variable Costing
Absorption Costing
Cost of Goods Manufactured

Direct Direct Variable Fixed

Materials Labor Factory OH Factory OH

Cost of Goods Manufactured Period Expense

Variable Costing
 Units Manufactured Equal Units Sold
Variable Costing Income Statement
Sales (15,000 x $50) $750,000
Variable cost of goods sold:
Variable cost of goods mfg.
(15,000 x $25) $375,000
Less ending inventory 0
Variable cost of goods sold 375,000
Manufacturing margin $375,000
Variable selling and administrative
expenses (15,000 x $5) 75,000
Contribution margin $300,000
Fixed costs:
Fixed manufacturing costs $150,000
Fixed selling and administrative
expenses 50,000 200,000
Income from operations $100,000
 Units Manufactured Equal Units Sold
Absorption Costing Income Statement
Sales (15,000 x $50) $750,000
Cost of goods sold:
Cost of goods manufactured
(15,000 x $35) $525,000
Less ending inventory 0
Cost of goods sold 525,000
Gross profit $225,000
Selling and administrative expenses
($75,000 + $50,000) 125,000
Income from operations $100,000

When the number of units manufactured equals the

number of units sold, income from operations will be
the same under both methods.
 Units Manufactured Exceed Units Sold
Variable Costing Income Statement
Sales (12,000 x $50) $600,000
Variable cost of goods sold:
Variable cost of goods manufactured
(15,000 x $25) $375,000
Less ending inventory (3,000 x $25) 75,000
Variable cost of goods sold 300,000
Manufacturing margin $300,000
Variable selling and admin. expenses 60,000
Contribution margin $240,000
Fixed costs:
Fixed manufacturing costs $150,000
Fixed selling and admin. expenses 50,000 200,000
Income from operations $ 40,000
 Units Manufactured Exceed Units Sold
Absorption Costing Income Statement
Sales (12,000 x $50) $600,000
Cost of goods sold:
Cost of goods manufactured
(15,000 x $35) $525,000
Less ending inventory (3,000 x $35) 105,000
Cost of goods sold 420,000
Gross profit $180,000
Selling and administrative expenses
[(12,000 x $5) + $50,000] 110,000
Income from operations $ 70,000
Units Manufactured Exceed Units Sold

Operating Income:
Absorption costing $70,000
Variable costing 40,000
Difference $30,000

Why is absorption costing income higher

when units manufactured exceed units sold?
Units Manufactured Exceed Units Sold

Operating Income:
Absorption costing $70,000
Variable costing 40,000
Difference $30,000
Analysis:
Units manufactured 15,000
Units sold 12,000
Ending inventory units 3,000
Fixed cost per unit x $10
Difference $30,000
 Units Manufactured Are Less Than Units Sold
Variable Costing Income Statement
Sales (15,000 x $50) $750,000
Variable cost of goods sold:
Beginning inventory (5,000 x $25) $125,000
Variable cost of goods manufactured
(10,000 x $25) 250,000 375,000
Manufacturing margin $375,000
Variable selling and admin. expenses 75,000
Contribution margin $300,000
Fixed costs:
Fixed manufacturing costs $150,000
Fixed selling and admin. expenses 50,000 200,000
Income from operations $100,000
 Units Manufactured Are Less Than Units Sold
Variable Costing Income Statement
Sales (15,000 x $50) $750,000
Variable cost of goods sold:
Beginning inventory (5,000 x $25) $125,000
Variable cost of goods manufactured
(10,000 x $25) 250,000 375,000
Manufacturing margin $375,000
Variable selling and admin. expenses 75,000
Contribution margin $300,000
Fixed costs:
Fixed manufacturing costs $150,000
Fixed selling and admin. expenses 50,000 200,000
Income from operations $100,000
 Units Manufactured Are Less Than Units Sold
Absorption Costing Income Statement
Sales (15,000 x $50) $750,000
Cost of goods sold:
Beginning inventory (5,000 x $35) $175,000
Cost of good manufactured
(10,000 x $45) 400,000
Cost of goods sold 575,000
Gross profit $175,000
Selling and administrative expenses
($75,000 + $50,000) 125,000
Income from operations $ 50,000
Units Manufactured Are Less Than Units Sold
Operating Income:
Variable costing $100,000
Absorption costing 50,000
Difference $ 50,000

Why is variable costing income

higher when units manufactured are
less than units sold?
Units Manufactured Are Less Than Units Sold
Operating Income:
Variable costing $100,000
Absorption costing 50,000
Difference $ 50,000

Analysis:
Units sold 15,000
Units manufactured 10,000
Beginning inventory units 5,000
Fixed cost per unit x $10
Difference $50,000
 IF Units Sold < Units produced

THEN Variable Costing < Absorption Costing

Income Income
 IF Units Sold > Units produced

THEN Variable Costing > Absorption Costing

Income Income
Income Analysis Under Variable Costing
and Absorption Costing

Frand Manufacturing
Company has no beginning
inventory and sales are
estimated to be 20,000 units at
$75 per unit, regardless of
production levels.
 Income Analysis Under Variable Costing
and Absorption Costing
Proposal 1: 20,000 Units to Be Manufactured and Sold
Total Cost Unit Cost
Manufacturing costs:
Variable $ 700,000 $35
Fixed 400,000 20
Total costs $1,100,000 $55
Selling and administrative exp.
Variable ($5 per unit sold) $ 100,000
Fixed 100,000
Total expenses $ 200,000
 Income Analysis Under Variable Costing
and Absorption Costing
Proposal 2: 25,000 Units to Be Manufactured; 20,000 Units to Be Sold
Total Cost Unit Cost
Manufacturing costs:
Variable $ 875,000 $35
Fixed 400,000 16
Total costs $1,275,000 $51
Selling and administrative exp.
Variable ($5 per unit sold) $ 100,000
Fixed 100,000
Total expenses $ 200,000
 Frand Manufacturing Company
Absorption Costing Income Statements
20,000 Units 25,000 Units
Manufactured Manufactured
Sales $1,500,000 $1,500,000
Cost of goods sold:
Cost of goods manufactured
(20,000 units x $55) $1,100,000
 Frand Manufacturing Company
Absorption Costing Income Statements
20,000 Units 25,000 Units
Manufactured Manufactured
Sales $1,500,000 $1,500,000
Cost of goods sold:
Cost of goods manufactured
(20,000 units x $55) $1,100,000
(25,000 units x $51) $1,275,000
 Frand Manufacturing Company
Absorption Costing Income Statements
20,000 Units 25,000 Units
Manufactured Manufactured
Sales $1,500,000 $1,500,000
Cost of goods sold:
Cost of goods manufactured
(20,000 units x $55) $1,100,000
(25,000 units x $51) $1,275,000
Less ending inventory:
(5,000 units x $51) 255,000
Cost of goods sold $1,100,000 $1,020,000
Gross profit $ 400,000 $ 480,000
Selling and administrative expenses
($100,000 + $100,000) 200,000 200,000
Income from operations $ 200,000 $ 280,000
 Frand Manufacturing Company
Variable Costing Income Statements
20,000 Units 25,000 Units
Manufactured Manufactured
Sales $1,500,000 $1,500,000
Variable cost of goods sold:
Variable cost of goods manufactured:
(20,000 units x $35) $ 700,000
(25,000 units x $35) $ 875,000
 Frand Manufacturing Company
Variable Costing Income Statements
20,000 Units 25,000 Units
Manufactured Manufactured
Sales $1,500,000 $1,500,000
Variable cost of goods sold:
Variable cost of goods manufactured:
(20,000 units x $35) $ 700,000
(25,000 units x $35) $ 875,000
Less ending inventory:
(0 units x $35) 0
(5,000 units x $35) 175,000
Variable cost of goods sold $ 700,000 $ 700,000
Manufacturing margin $ 800,000 $ 800,000

Continued
 Frand Manufacturing Company
Variable Costing Income Statements
20,000 Units 25,000 Units
Manufactured Manufactured

Manufacturing margin $ 800,000 $ 800,000

Variable selling and administrative
expenses 100,000 100,000
Contribution margin $ 700,000 $ 700,000
Fixed costs:
Fixed manufacturing costs $ 400,000 $ 400,000
Fixed selling and administrative
expenses 100,000 100,000
Total fixed costs $ 500,000 $ 500,000
Income from operations $ 200,000 $ 200,000
 Frand Manufacturing Company
Variable Costing Income Statements
Suppose 30000 units were manufactured 30,000 Units
Manufactured
Sales $1,500,000
Variable cost of goods sold:
Variable cost of goods manufactured:
(30,000 units x $35) $1,050,000
Less ending inventory:
(10,000 units x $35) 350,000
Variable cost of goods sold $ 700,000
Manufacturing margin $ 800,000

Continued
 Frand Manufacturing Company
Variable Costing Income Statements
30,000 Units
Manufactured
Manufacturing margin $ 800,000
Variable selling and administrative
expenses 100,000
Contribution margin $ 700,000
Fixed costs:
Fixed manufacturing costs $ 400,000
Fixed selling and administrative
expenses 100,000
Total fixed costs $ 500,000
Income from operations $ 200,000
Management’s Use of Costing Methods
Variable costing reports and absorption
costing reports are useful in the following
situations:
1. Controlling costs
2. Pricing products
3. Planning production
4. Analyzing market segments
5. Analyzing contribution margins
Accounting Reports and
Management Decisions
ACCOUNTING REPORTS

Absorption Costing and Variable Costing

MANAGEMENT