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Absorption Costing (AC) & Variable Costing (VC)

Absorption Costing (AC) & Variable Costing (VC). Differences between AC and VC Calculation of Product Cost under AC and VC VC and AC : A comparison of their impact on profit Arguments in support of VC Arguments in support of AC. Differences between AC and VC. Absorption Costing

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Absorption Costing (AC) & Variable Costing (VC)

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  1. Absorption Costing (AC) &Variable Costing (VC) Differences between AC and VC Calculation of Product Cost under AC and VC VC and AC : A comparison of their impact on profit Arguments in support of VC Arguments in support of AC

  2. Differences between AC and VC • Absorption Costing • Assign all manufacturing costs to products • Non manufacturing cost treated as period cost i.e excluded from inventory valuation • Allowed for external reporting • Variable costing • Only variable manufacturing costs are assigned to products and included in inventory valuation • Fixed manufacturing costs are not assigned to products • Only for internal reporting

  3. Calculation of Product Cost • Under AC • Product Cost • Direct Material costs • Direct Labour costs • Variable Overhead Manufacturing costs • Allocated Fixed Manufacturing Overhead

  4. Calculation of Product Cost • Under VC • Product Cost • Direct Material costs • Direct Labour costs • Variable Overhead Manufacturing costs

  5. VC and AC : A comparison of their impact on profit • Production equals sales • AC profit equals VC profits • Production exceeds sales • AC profit greater than VC profit • Sales exceeds production • VC profit greater than AC profit

  6. LO 2 INVENTORY VALUATION: Background

  7. LO 2 ABSORPTION COSTING Value of ending inventory = 2,000 x RM 225 = RM 450,000

  8. LO 2 VARIABLE COSTING Value of ending inventory = 2,000 x $ 200 = $ 400,000

  9. LO 2 COMPARATIVE INCOME STATEMENTS Income lower under variable costing where fixed costs are expensed for period.

  10. LO 2 ABSORPTION INCOME STATEMENT COGS = 8,000 x $ 225 = $ 1,800,000

  11. LO 2 VARIABLE INCOME STATEMENT Variable costs: 8,000 x $200 Fixes costs: $250,000 + 100,000

  12. LO 2 ABSORPTION VS. VARIABLE If more is sold than produced, variable costing income > absorption-costing income, opposite of Fairchild situation. Equal production & sales means equal income.

  13. How do variable & absorption costing affect performance evaluation? Variable costing ensures that direct relationship between sales & income holds whereas absorption costing does not.

  14. LO 2 EXPLANATION The difference between variable costing & absorption costing year to year is equal to the change in fixed overhead. Under absorption costing, fixed overhead is assigned to inventory produced. Under variable costing, fixed overhead is a period expense.

  15. Some arguments in support of Variable Costing • VC provides more useful information for decision making • VC removes from profit the effect of inventory changes • VC avoids fixed overhead being capitalised in unsaleable stocks

  16. Some arguments in support of Absorption Costing • AC does not understate the importance of Fixed costs • AC avoids fictitious losses being reported • Fixed overhead are essential for production • Consistency with external reporting

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