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 the
regardless of the difference between sold and unsold units.
production and sales volume.
2. The portion of the cost, which has been
2. Does not form part of the cost of allocated to the unsold units, becomes part
inventory. of the inventory.

3. Diminishes income for the current 3. Diminishes current income by that

period by its full amount. portion thereof identified with the sold
units only 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:

Variable Absorption

Treatment of Fixed Factory Period Product

Overhead (Full Amount) (Proportional Amount)

Required by PFRS X /

Focus of Reporting Internal External

Income Statement Format CM/CVP Traditional/Conventional

Income Fluctuates with Sales Production

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.
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. 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

3. 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

4. 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

5. 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

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

1. The following data relate to a company’s first year of operation, when 20,000 units were
produced, and 18,000 units were sold.

Variable costs per unit:

Direct material ₱40

Direct labor 20
Variable overhead 14

Variable selling costs 12

Fixed costs:

Selling and administrative ₱750,000

Manufacturing 400,000

Selling price ₱160

REQUIRED:
a. Compute the product costs per unit under absorption and variable costing. P94/P74
b. Compute the costs of ending inventory under absorption and variable costing.
P188,000/P148,000

c. Prepare income statements based on absorption and variable costing.

d. Explain the difference in income between the two costing methods.

2. A Company began its operations on January 1, 2024, and produces a single product that sells
for ₱10.00 per unit. It uses an actual (historical) cost system. In 2024, 100,000 units were produced,
and 80,000 units were sold. There was no work-in-process inventory on December 31, 2024.
Manufacturing costs and selling and administrative expenses for 2024 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

a. What would be the company’s operating income for 2024 under the variable (direct) costing
method? P210,000

b. What would be the company’s finished goods inventory on December 31, 2024 under the
absorption costing method? P104,000

3. 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? P625

4. 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. P90