Administrative expenses treated as product costs
What is the basic
difference between absorption costing and variable costing?
·
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 immediately expensed
on the income statement.
Are selling and
administrative expenses treated as product costs or as period costs under
variable costing?
·
Selling and
administrative expenses are treated as period costs under both variable costing
and absorption costing.
Explain how fixed
manufacturing overhead costs are shifted from one period to another
under 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. 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 the units produced
and unit sales are equal, which method would you expect to show
the higher net operating income, variable costing or absorption costing? Why?
·
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 the units produced
exceed unit sales, which method would you expect to show the
higher net operating income, variable costing or absorption costing? Why?
·
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.
If fixed manufacturing
overhead costs are released from inventory under absorption costing, what does
this tell you about the level of production in relation to the level
of sales?
·
If fixed manufacturing
overhead cost is released from inventory, then inventory levels must have
decreased and therefore production must have been less than sales.
Under absorption
costing, how is it possible to increase net operating income without
increasing sales?
·
Under absorption
costing net operating income can be increased by simply increasing the level of
production without any increase in sales. If production exceeds sales, units of
product are added to inventory. These units carry a portion of the current
period's fixed manufacturing overhead costs into the inventory account,
reducing the current period's reported expenses and causing net operating
income to increase.
Period Costs
·
Costs that are not a
necessary part of the manufacturing process. As a result, period costs cannot
be assigned to the products or to the cost inventory.
They are expensed immediately as incurred
Product Costs
·
Costs used in making
its products. Includes: D/M, D/L, M/O.
Inventory costs because they go into inventory (Balance sheet > income
statement)
Loss but positive CVP
analysis
·
Sales were above the
company's break-even sales and yet the company sustained a loss. The apparent
contradiction is explained by the fact that the CVP analysis is based on
variable costing, whereas the income reported to shareholders is prepared using
absorption costing. Because sales were above the break-even point, the variable
costing net operating income would have been positive. However, the absorption
costing net operating income was negative. Ordinarily, this would only happen
if inventories decreased and fixed manufacturing overhead deferred in
inventories was released to the income statement on the absorption costing
income statement. This added fixed manufacturing overhead cost resulted in a
loss on an absorption costing basis even though the company operated at its
break-even point on a variable costing basis.
How to add and deduct
MOH
·
Add: Fixed
manufacturing overhead cost deferred in inventory under absorption
costing
Deduct: Fixed manufacturing overhead cost
released from inventory under absorption
costing
Per unit fixed MOH
·
fixed MOH / units
produced
USA 
India