Manaerial Accounting Chapter 7 Solutions
Absorption and variable costing differ in how they handle fixed manufacturing overhead. Under absorption costing, fixed manufacturing overhead is treated as a product cost and hence is an asset until products are sold. Under variable costing, fixed manufacturing overhead is treated as a period cost and is expensed on the current period’s income statement.
Selling and administrative expenses are treated as period costs under both variable costing and absorption costing.
Under absorption costing, fixed manufacturing overhead costs are included in product costs, along with direct materials, direct labor, and variable manufacturing overhead. If some of the units are not sold by the end of the period, then they are carried into the next period as inventory. The fixed manufacturing overhead cost attached to the units in ending inventory follow the units into the next period. When the units are finally sold, the fixed manufacturing overhead cost that has been carried over with the units is included as part of that period’s cost of goods sold.
If production and sales are equal, net operating income should be the same under absorption and variable costing. When production equals sales, inventories do not increase or decrease and therefore under absorption costing fixed manufacturing overhead cost cannot be deferred in inventory or released from inventory.
If production exceeds sales, absorption costing will usually show higher net operating income than variable costing. When production exceeds sales, inventories increase and under absorption costing part of the fixed manufacturing overhead cost of the current period is deferred in inventory to the next period. In contrast, all of the fixed manufacturing overhead cost of the current period is immediately expensed under variable costing.
Generally speaking, variable costing cannot be used externally for financial reporting purposes nor can it be used