CPAR

CPA REVIEW SCHOOL OF THE PHILIPPINES

Manila
MAS 9704
MANAGEMENT ADVISORY SERVICES

PRODUCT COSTING
ABSORPTION COSTING (also called full costing, conventional costing)
– costing method that includes all manufacturing costs (direct materials, direct labor, and both
variable and fixed manufacturing overhead) in the cost of a unit of product. It treats fixed
manufacturing overhead as a product cost.

VARIABLE COSTING (also called direct costing)

– costing method that includes only variable manufacturing costs (direct materials, direct labor,
and variable manufacturing overhead) in the cost of a unit of product. It treats fixed
manufacturing overhead as a period cost.

DISTINCTIONS BETWEEN PERIOD COSTS AND PRODUCT COSTS:

PERIOD COST PRODUCT COST

1. Refers to an item charged against current 1. Refers to an item included in product
revenue on the basis of time period costing which is apportioned between
regardless of the difference between the sold and unsold units.
production and sales volume.
2. Does not form part of the cost of 2. The portion of the cost, which has been
inventory. allocated to the unsold units, becomes
part of the inventory.
3. Diminishes current income by that portion
3. Diminishes income for the current period thereof identified with the sold units only
by its full amount. with the remainder being deferred to the
next accounting period as part of the cost
of ending inventory.

PRINCIPAL DIFFERENCES BETWEEN VARIABLE AND CONVENTIONAL ABSORPTION

COSTING:
ABSORPTION COSTING VARIABLE COSTING
Seldom segregates costs into Costs are segregated into variable
1. Cost segregation
variable and fixed costs and fixed
Cost of inventory includes all the Cost of inventory includes only the
manufacturing costs: materials, variable manufacturing costs:
2. Cost of Inventory
labor, variable factory overhead, materials, labor, and variable
and fixed factory overhead factory overhead
3. Treatment of
Fixed factory overhead is treated Fixed factory overhead is treated
fixed factory
as product cost. as period cost.
overhead
Distinguishes between variable
Distinguishes between production
4. Income and fixed costs.
and other costs.
statement

Net income between the two methods may differ from each other
because of the difference in the amount of fixed overhead costs
recognized as expense during an accounting period. This is due to
5. Net income variations between sales and production. In the long run, however,
both methods give substantially the same results since sales cannot
continuously exceed production, nor production can continually exceed
sales.
 MAS 9704 PRODUCT COSTING Page 2 of 11

DIFFERENCE IN NET INCOME UNDER ABSORPTION AND VARIABLE COSTING:

Variable and absorption costing methods of accounting for fixed manufacturing overhead result in
different levels of net income in most cases. The differences are timing differences, i.e., when to
recognize the fixed manufacturing overhead as an expense. In variable costing, it is expensed
during the period when the fixed overhead is incurred, while in absorption costing, it is expensed in
the period when the units to which such fixed overhead has been related are sold.

Production Equals Sales:

When production is equal to sales, there is no change in inventory. Fixed overhead expensed under
absorption costing equals fixed overhead expensed under variable costing. Therefore, absorption
costing income equals variable costing income.

Production is Greater Than Sales

When production is greater than sales, there is an increase in inventory. Fixed overhead expensed
under absorption costing is less than fixed overhead expensed under variable costing. Therefore,
absorption income is greater than variable costing.

Production is Less Than Sales

When production is less than sales, there is decrease in inventory. Fixed overhead expensed under
absorption is greater than fixed overhead expensed under variable costing. Therefore, absorption
income is less than variable costing income.

ARGUMENTS FOR THE USE OF VARIABLE COSTING

1. Variable costing reports are simpler and more understandable.
2. Data needed for break-even and cost-volume-profit analyses are readily available.
3. The problems involved in allocating fixed costs are eliminated.
4. Variable costing is more compatible with the standard cost accounting system.
5. Variable costing reports provide useful information for pricing decisions and other decision-
making problems encountered by management.

ARGUMENTS AGAINST VARIABLE COSTING

1. Segregation of costs into fixed and variable might be difficult, particularly in the case of mixed
costs.
2. The matching principle is violated by using variable costing which excludes fixed overhead from
product costs and charges the same to period costs regardless of production and sales.
3. With variable costing, inventory costs and other related accounts, such as working capital,
current ratio, and acid-test ratio are understated because of the exclusion of fixed overhead in
the computation of product cost.

THROUGHPUT COSTING (or SUPERVARIABLE COSTING)

An extreme form of variable costing in which only direct material costs are included as
inventoriable costs. All other costs are costs of the period in which they are incurred.

Throughput margin = Revenue – Direct material cost of the goods sold

 MAS 9704 PRODUCT COSTING Page 3 of 11

EXERCISES:

1. The following data relate to a company’s first year of operation, when 2,000 units were produced
and 1,600 units were sold.

Variable costs per unit:

Direct material ₱4.00
Direct labor 2.00
Variable overhead 1.40
Variable selling costs 1.20

Fixed costs:
Selling and administrative ₱5,000
Manufacturing 4,000

Selling price ₱15

REQUIRED:
1. Compute the product costs per unit under absorption and variable costing.
2. Compute the costs of ending inventory under absorption and variable costing.
3. Prepare income statements based on absorption and variable costing.
4. Explain the difference in income between the two costing methods.
5. Compute the throughput margin and income under throughput costing.

2. A company uses an absorption costing system based on standard costs. Following are some
data about the company’s operations in 2024:

Selling price per unit ₱8

Total variable manufacturing costs per unit ₱4
Total budgeted and actual fixed manufacturing overhead costs ₱42,000
Normal capacity in units 60,000
Variable marketing and administrative costs, driven by units sold ₱1.2
Fixed marketing and administrative costs ₱12,000
Actual variable manufacturing costs incurred in 2024 ₱230,000

Beginning inventory in 2024 2,000 units

Ending inventory 3,000 units
. Sales in 2024 55,000 units.

The same standard unit costs persisted throughout 2023 and 2024.

Required:
1. Prepare an income statement for 2024 assuming that all variances are written off directly
at year-end as an adjustment to Cost of Goods Sold.
2. The president has heard about variable costing. He asks you to recast the 2024 income
statement as it would appear under variable costing.
3. Explain the difference in operating income as calculated in requirements 1 and 2.

3. A company produces and sells a product. The firm uses variable costing for internal
management purposes and absorption costing for external purposes. At the end of each
year, financial information must be converted from variable costing to absorption costing to
satisfy external requirements.

It is anticipated that sales would increase in 2024 from the 2023 levels. Therefore,
production was increased from 20,000 to 21,000 units to meet the expected demand.
However, economic conditions kept the sales level at 18,000 for both years. The following
data pertain to 2023 and 2024:
 MAS 9704 PRODUCT COSTING Page 4 of 11

2023 2024
Selling price per unit ₱55 ₱55
Sales (units) 18,000 18,000
Beginning inventory (units) 4,000 ?
Production (units) 20,000 21,000
Ending inventory (units) 6,000 ?
Net unfavorable variable manufacturing
cost variances ₱6,000 ₱12,000

Standard variable manufacturing costs per unit for 2023 and 2024 were:

Materials ₱ 8.00
Labor 10.00
Overhead 6.00
Total ₱24.00

Variable selling and administrative costs amounted to ₱5 per unit.

Annual fixed costs for 2023 and 2024 (budgeted and actual) were:

Production ₱200,000
Selling and administrative 160,000
Total ₱360,000

The overhead rate under absorption costing is based on practical capacity of 20,000 units
per year. All variances and under- or overapplied overhead are taken to Cost of Goods Sold.
All taxes are to be ignored.

Required:
1. Prepare income statements based on absorption costing and variable costing for
2024.
2. Explain the difference, if any, in the income figures.

4. A company reports the following variable costing income statement for its single product.
This company’s sales totaled 40,000 units, but its production was 30,000 units.

Sales (40,000 units x ₱60) ₱2,400,000

Variable costs:
Manufacturing (40,000 units @ ₱25 per unit) ₱1,000,000
Selling and administrative (40,000 x ₱5) 200,000 1,200,000
Contribution margin ₱1,200,000
Fixed costs:
Factory overhead ₱ 300,000
Selling and administrative 100,000 400,000
Income ₱ 800,000

Required:
1. Convert the company’s variable costing income statement to an absorption costing
income statement.
2. Explain the difference in income between the two costing methods.

5. A company began operations this year. During this first year, the company produced 800
units of its only product and sold 750 units. At the current year-end, the company reported
the following income statement information using absorption costing.
MAS 9704 PRODUCT COSTING Page 5 of 11

Sales (750 x ₱1,000) ₱750,000

Cost of goods sold (750 x ₱325) 243,750
Gross margin ₱ 506,250
Selling and administrative expenses 300,000
Net income ₱ 206,250

Additional Information
a. Production cost per unit of product totals ₱325, which consists of ₱200 in variable
production cost and ₱125 in fixed production cost—the latter amount is based on
₱100,000 of fixed production costs allocated to the 800 units produced.
b. The ₱300,000 in selling and administrative expense consists of ₱180,000 that is
variable and ₱120,000 that is fixed.

REQUIRED:
1. Prepare an income statement for the current year under variable costing.
2. Explain the difference in income between the variable costing and absorption
costing income statement.

6. The following information pertains to a company:

Maximum productive capacity 24,000 units per year
Normal capacity 20,000 units
Standard variable manufacturing cost per unit ₱30
Fixed factory overhead ₱80,000
Variable selling expenses per unit ₱4
Fixed selling expenses ₱30,000
Unit sales price ₱60

2024 operating results:

Sales 22,000 units
Production 18,000 units

Net favorable variance for standard variable manufacturing cost ₱10,000

REQUIRED: 1. Income under both costing methods.

2. Break-even point
3. Margin of safety for 2024

7. A company produces and sells a single product. The following costs relate to its production
and sales during its first year of operations:
Variable costs per unit:
Materials ₱12
Direct labor 30
Conversion cost 50
Selling and administrative expenses 5

Fixed costs per year:

Manufacturing overhead ₱400,000
Selling and administrative expenses 200,000

During the year, 50,000 units were produced, and 48,000 units were sold. The finished
Goods Inventory account at the end of the year shows a balance of ₱124,000.

REQUIRED: 1. Is the company using absorption costing or variable costing to cost units
in the Finished Goods inventory account?

2. Assume that the company wishes to prepare financial statements for

external reporting purposes.
MAS 9704 PRODUCT COSTING Page 6 of 11

a. Is the ₱124,000 figure for Finished Goods inventory the correct

amount to use on these statements for external reporting purposes?
Explain.

b. At what peso amount should the finished goods inventory be carried

under ABSORPTION Costing?

8. During its first year of operations, a company produced 52,000 units of its only product.
Unit sales were 50,000. Fixed overhead was applied at ₱4 per unit produced. Fixed
overhead was underapplied by ₱20,000. The favorable variable manufacturing cost variance
amounted to ₱60,000. The manufacturing cost variances were closed to Cost of Goods
Sold. The results of the year’s operations are as follows (on an absorption-costing basis):

Sales (50,000 units @ ₱14) ₱700,000

Cost of goods sold 500,000
Gross profit ₱200,000
Selling and administrative expenses:
Variable ₱80,000
Fixed 40,000 120,000
Profit ₱ 80,000

REQUIRED: 1. Give the cost of the firm’s ending inventory under absorption costing. What
is the cost of the ending inventory under variable costing?
2. Compute the income under variable costing. Reconcile the difference
between the two income figures.

9. “Now this doesn’t make any sense at all,” said the financial vice president for a company.
“Our sales have been steadily rising over the last several months, but profits have been
going in the opposite direction. In September we finally hit ₱2,000,000 in sales, but the
bottom line for that month drops off to a ₱100,000 loss. Why aren’t profits more closely
correlated with sales?”

The statements to which financial vice president was referring are shown below:

July August September

Sales (@₱25) ₱1,750,000 ₱1,875,000 ₱2,000,000
Less cost of goods sold:
Beginning inventory 80,000 320,000 400,000
Cost applied to production:
Variable manufacturing costs 765,000 720,000 540,000
Fixed manufacturing overhead 595,000 560,000 420,000
Cost of goods manufactured 1,360,000 1,280,000 960,000

Goods available for sale 1,440,000 1,600,000 1,360,000

Less ending inventory 400,000 80,000
320,000
Cost of goods sold 1,120,000 1,200,000 1,280,000
Underapplied or (overapplied) fixed
Overhead cost (35,000) -0-
140,000
Adjusted cost of goods sold 1,085,000 1,200,000 1,420,000
Gross margin 665,000 675,000 580,000
Less selling and administrative expenses 620,000 650,000 680,000
Net income (loss) ₱ 45,000 ₱ 25,000 ₱ (100,000)

A new graduate from a state university who has just been hired by the company, has stated
to the financial vice president that the contribution approach, with variable costing, is a
 MAS 9704 PRODUCT COSTING Page 7 of 11

much better way to report profit data to management. Sales and production data for the
last quarter follow:
July August September
Production in units 85,000 80,000 60,000
Sales in units 70,000 75,000 80,000

Additional information about the company’s operations is given below:

a. Five thousand units were in inventory on July 1.
b. Fixed manufacturing overhead costs total ₱1,680,000 per quarter and are incurred
evenly throughout the quarter. This fixed manufacturing overhead cost is applied
to units of product on the basis of a budgeted production volume of 80,000 units
per month.
c. Variable selling and administrative expenses are ₱6 per unit sold. The remainder
of the selling and administrative expenses on the statements above are fixed.
d. The company uses a FIFO inventory flow assumption. Work in process inventories
are insignificant and can be ignored.

“I know production is somewhat out of step with sales,” said the company’s controller. “But
we had to build inventory early in the quarter in anticipation of a strike in September. Since
the union settled without a strike, we then had to cut back production in September in order
to work off the excess inventories. The income statements you have are completely
accurate.”

REQUIRED:
Assume that the company had decided to introduce JIT inventory methods at the
beginning of September. (Sales and production during July and August were as
shown above.)
a. How many units would have been produced during September under JIT?
b. Starting with the next quarter (October – December) would you expect any
difference between the income reported under absorption costing and under
variable costing? Explain why there would or would not be any difference.

SELF TEST -PRODUCT COSTING

1. The term that means all manufacturing costs (direct and indirect, fixed and variable) which can
contribute to the production of the product, are traced to output and inventories is:
a. job order costing c. absorption costing
b. process costing d. direct costing

2. The term that is most descriptive of the type of cost accounting often called direct costing is:
a. out-of-pocket costing c. relevant costing
b. variable costing d. prime costing

3. Costs treated as product costs under direct costing are:

a. prime costs only c. all variable costs
b. variable production cost only d. all variable and fixed manufacturing costs

4. The basic assumption made in direct costing with respect to fixed costs is that fixed cost is:
a. a controllable cost c. an irrelevant cost
b. a product cost d. a period cos

5. Operating income computed using the direct costing would generally exceed operating income
computed using the absorption costing if:
a. units sold exceed units produced
b. units sold are less than units produced
c. units sold equal units produced
d. the unit fixed cost is zero
 MAS 9704 PRODUCT COSTING Page 8 of 11

6. A company has operating income of ₱50,000 using direct costing for a given period. Beginning
and ending inventories for that period were 13,000 units and 18,000 units, respectively. If the fixed
factory overhead application rate is ₱2 per unit, the operating income using the absorption costing
is:
a. ₱40,000 c. ₱60,000
b. ₱50,000 d. Not determinable from the information
given

7. Absorption costing differs from variable costing in the:

a. fact that standard costs can be used with absorption costing but not with direct costing
b. kinds of activities for which each can be used to report
c. amounts of costs assigned to individual units of product
d. amount of fixed costs that will be incurred

8. When a firm uses direct costing

a. the cost of a unit product changes because of changes in the number of units
manufactured.
b. profits fluctuate with sales.
c. an idle capacity variance is calculated by a direct costing method.
d. product costs include variable administrative costs.

9. When using direct-costing information, the contribution margin discloses the excess of:
a. revenue over fixed cost
b. projected revenue over the break-even point
c. revenue over variable cost
d. variable over fixed cost

10. Operating income under absorption costing can be reconciled to operating income determined
under direct costing by computing the difference between:
a. inventoried fixed costs in the beginning and ending inventories and any deferred over or
underapplied fixed factory overhead.
b. inventoried discretionary costs in the beginning and ending inventories
c. gross profit (absorption costing method) and contribution margin (direct costing)
d. sales recorded under the absorption costing method

11. Under the direct costing concept, unit product cost would most likely be increased by:
a. a decrease in the remaining useful life of factory machinery depreciated by the units-of-
production method
b. a decrease in the number of units produced
c. a decrease in the remaining useful life of factory machinery depreciated by the sum-of-
the-years-digits method
d. an increase in the commission paid to salespersons for each unit sold.

ITEMS 12 and 13 ARE BASED ON THE FOLLOWING INFORMATION:

Selected information concerning the operations of Prima Donna Company for the year ended
December 31, 2022, is available as follows:

Units produced 10,000

Units sold 9,000
Direct materials used ₱40,000
Direct labor cost incurred 20,000
Fixed factory overhead 25,000
Variable factory overhead 12,000
Fixed selling and administrative expenses 30,000
Variable selling and administrative expenses 4,500
Finished goods inventory, January 1, 2021 None

There were no work-in-process inventories at the beginning and end of 2022.

12. What would be Prima Donna’s finished goods inventory cost at December 31, 2022, under the
variable (direct) costing method?
a. ₱7,200 c. ₱8,000
b. ₱7,650 d. ₱9,700
 MAS 9704 PRODUCT COSTING Page 9 of 11

13. Which costing method, absorption or variable, would show a higher operating income for 2022
and by what amount?
Costing method Amount
a. Absorption costing ₱2,500
b. Variable costing ₱2,500
c. Absorption costing ₱5,500
d. Variable costing ₱5,500

14. A corporation began its operations on January 1, 2022, and produces a single product that sells
for ₱9.00 per unit. The company uses an actual (historical) cost system. 100,000 units were
produced and 90,000 units were sold in 2022. There was no work-in-process inventory at
December 31, 2022. Manufacturing costs and administrative expenses for 2022 were as follows:

Fixed costs Variable costs

Raw materials – ₱ 1.75 per unit produced
Direct labor – ₱ 1.25 per unit produced
Factory overhead ₱100,000 ₱ 0.50 per unit produced
Selling and administrative 70,000 ₱ 0.60 per unit sold

What would be the company’s operating income for 2022 using the direct costing method?
a. ₱181,000 c. ₱281,000
b. ₱271,000 d. ₱371,000

15. Operating income using direct costing as compared to absorption costing would be higher
a. when the quantity of beginning inventory equals the quantity of ending inventory.
b. when the quantity of beginning inventory is more than the quantity of ending inventory.
c. when the quantity of beginning inventory is less than the quantity of ending inventory.
d. under no circumstances.

16. When using full absorption costing, what costs attendant to an element of production (material,
labor, and overhead) are used in order to compute variances from standard amount?
a. Controllable costs c. Variable costs
b. Total costs d. Fixed costs

17. What factor, related to manufacturing costs, causes the difference in net earnings computed
using absorption costing and net earnings computed using direct costing?
a. Absorption costing considers all costs in the determination of net earnings, whereas direct
costing considers only direct costs.
b. Absorption costing allocates fixed costs between cost of goods sold and inventories, while
direct costing considers all fixed costs to be period costs.
c. Absorption costing “inventories” all direct costs, but direct costing considers direct costs to
be period costs.
d. Absorption costing “inventories” all fixed costs for the period in ending finished goods
inventory, but direct costing expenses all fixed costs.

18. A basic tenet of direct costing is that period costs should be currently expensed. What is the
basic rationale behind this procedure?
a. Period costs are uncontrollable and should not be charged to a specific product.
b. Period costs are generally immaterial in amount and the cost of assigning the amount to
specific products would outweigh the benefits.
c. Allocation of period costs is arbitrary at best and could to erroneous decisions by
management.
d. Period costs will occur whether or not production occurs and so it is improper to allocate
these costs to production and defer a current cost of doing business.

19. The contribution margin increases when sales volume remains the same and
a. variable cost per unit decreases. c. fixed costs decrease.
b. variable cost per unit increases. d. fixed costs increase.

ITEMS 20 and 21 ARE BASED ON THE FOLLOWING INFORMATION:

A Company began its operations on January 1, 2022, and produces a single product that sells
for ₱10.00 per unit. It uses an actual (historical) cost system. In 2022, 100,000 units were
produced and 80,000 units were sold. There was no work-in-process inventory at December
MAS 9704 PRODUCT COSTING Page 10 of 11

31, 2022. Manufacturing costs and selling and administrative expenses for 2022 were as
follows:
Fixed costs Variable costs
Raw materials – ₱ 2.00 per unit
Direct labor – ₱ 1.25 per unit
Factory overhead ₱120,000 ₱ 0.75 per unit
Selling and administrative 70,000 ₱ 1.00 per unit

20. What would be the company’s operating income for 2022 under the variable (direct) costing
method?
a. ₱114,000 c. ₱234,000
b. ₱210,000 d. ₱330,000

21. What would be the company’s finished goods inventory at December 31, 2022 under the
absorption costing method?
a. ₱ 80,000 c. ₱110,000
b. ₱104,000 d. ₱124,000

22. The production volume variance occurs when using

a. the absorption costing approach because of production exceeding the sales.
b. the absorption costing approach because production differs from that used in setting the
fixed overhead rate used in applying fixed overhead to production.
c. the variable costing approach because of sales exceeding the production for the period.
d. the variable costing approach because of production exceeding the sales for the period.

23. A company completed its first year of operations during which time the following information
were generated:
Total units produced 100,000
Total units sold 80,000 (at ₱100 per unit)
Work in process ending inventory
Costs:
Fixed costs
Factory overhead ₱1.2 million
Selling and administrative ₱0.7 million

Per unit variable costs

Raw materials ₱20.00
Direct labor 12.50
Factory overhead 7.50
Selling and administrative 10.00

If the company used the variable (direct) costing method, the operating income would be
a. ₱2,100,000 c. ₱2,480,000
b. ₱4,000,000 d. ₱3,040,000

24. For ₱1,000 per box, a company produces and sells delicacies. Direct materials are ₱400 per
box and direct manufacturing labor averages ₱75 per box. Variable overhead is ₱25 per box
and fixed overhead is ₱12,500,000 per year. Administrative expenses, all fixed, run ₱4,500,000
per year, with sales commissions of ₱100 per box. Production is expected to be 100,000 boxes,
which is met every year. For the year just ended, 75,000 boxes were sold. What is the
inventoriable cost per box using absorption costing?
a. ₱625 c. ₱770
b. ₱500 d. ₱670

25. If sales exceed production, one would expect net income under the variable costing method
a. to be the same as net income under the absorption costing method.
b. to be greater than net income under the absorption costing method.
c. to be differing in as much as the difference between sales and production.
d. to be less than net income under the absorption costing method.

26. A company produces and sells boxes of signing pens for ₱1,000 per box. Direct materials are
₱400 per box and direct manufacturing labor averages ₱75 per box. Variable overhead is ₱25
per box and fixed overhead is ₱12,500,000 per year. Administrative expenses, all fixed, run
MAS 9704 PRODUCT COSTING Page 11 of 11

₱4,500,000 per year, with sales commissions of ₱100 per box. Production is expected to be
100,000 boxes, which is met every year. For the year just ended, 75,000 boxes were sold. What
is the inventoriable cost per box using variable costing?
a. ₱770 c. ₱475
b. ₱500 d. ₱625

27. A company reported the following per unit cost for the period just ended:
Direct materials ₱20
Direct labor 24
Variable overhead 2
Fixed overhead 14
Variable selling & administrative 4
Fixed selling & administrative 6

If the company were using the absorption approach or cost-plus pricing, and adds a 50% markup
to price its product, the selling price per unit would be
a. ₱ 75. c. ₱ 90.
b. ₱105. d. ₱ 69.

1. C 6. C 11. A 16. B 21. B 26. B

2. B 7. C 12. A 17. B 22. B 27. C
3. B 8. B 13. A 18. D 23. A
4. D 9. C 14. B 19. A 24. A
5. A 10. A 15. B 20. B 25. B

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