Absorption Direct Costing
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Full (Absorption) Costing vs. Variable (Direct) Costing 1
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Transcript of Absorption Direct Costing
Full (Absorption) Costing vs. Variable (Direct) Costing
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Overview Full (Absorption) Costing Variable (Direct) Costing Differences Between Full (Absorption)
Costing and Variable (Direct) Costing Product (Inventoriable) Costing Accounting for Fixed Overhead Operating Income
Reconciliation Between Full (Absorption) Costing and Variable (Direct) Costing
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Full (Absorption) Costing
Under GAAP,
product (inventoriable) cost= DM + DL + OH= DM + DL + var OH + fixed
OH
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Class ExampleRelevance of Fixed Costs?
production capacity = 10,000 unitsselling price = $20 per unitvariable mfg costs (relevant range = 5,000 to 10,000 units):
direct materials = $4 per unit
direct labour = $3 per unit
variable manufacturing overhead = $1 per unitfixed manufacturing overhead = $50,000variable selling and administrative costs = $2 per unitfixed selling and administrative costs = $15,000
Relevance of Fixed Costs
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Class ExampleRelevance of Fixed Costs?
Current Production = 8,000 unitsCurrent Sales = 8,000 unitsDecision Problem: Assuming that there are no
additional selling and administrative costs, should a special order for 1,500 units at a price of $12 be accepted?
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Relevance of Fixed Costs
Incremental revenue($1,500 units x $12)
$18,000
Class Example Relevance of Fixed Costs?
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Relevance of Fixed Costs
Incremental revenue($1,500 units x $12)
$18,000
Incremental costs($1,500 units x ($4+$3+$1))
12,000
Class Example Relevance of Fixed Costs?
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Relevance of Fixed Costs
Incremental revenue($1,500 units x $12)
$18,000
Incremental costs($1,500 units x ($4+$3+$1))
12,000
Net Contribution $6,000Decision: Accept special order.
Class Example Relevance of Fixed Costs?
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Variable (Direct) Costing
product cost= variable manufacturing costs= DM + DL + variable OH
because: fixed OH is irrelevant in decision making fixed OH is related to production
capacity but not production activity
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Differences Between Absorption and Direct Costing
Definition of product cost Accounting for fixed overhead Operating income
traditional approach vs. contribution approach
differences in operating income
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Class ExampleAbsorption vs Direct
Costing
production capacity = 10,000 unitsselling price = $20 per unitvariable mfg costs (relevant range = 5,000 to 10,000 units):
direct materials = $4 per unit
direct labour = $3 per unit
variable manufacturing overhead = $1 per unitfixed manufacturing overhead = $50,000variable selling and administrative costs = $2 per unitfixed selling and administrative costs = $15,000
Definition of Product Cost; Class Example - Accounting for Fixed Overhead; Class Example -Operating Income ; Reconciliation of Absorption and Direct Costing Income
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Class Example Absorption vs Direct
Costing
Current production = 8,000 unitsCurrent sales = 7,600 units
Product cost??Accounting for fixed OH??Operating income??
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Definition of Product Cost
Absorption Costing (GAAP)product cost = DM + DL + var OH +
fixed OH
Direct Costingproduct cost = DM + DL + var OH
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Definition of Product CostAbsorption
CostingDirect
Costing
Product cost
Manufacturing CGS
Inventory
Class Example Absorption vs Direct Costing
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Definition of Product CostAbsorption
CostingDirect
Costing
Product cost =$4+$3+$1+ $50,000/8,000
= $14.25 per unit
Manufacturing CGS
Inventory
Class Example Absorption vs Direct Costing
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Definition of Product CostAbsorption
CostingDirect
Costing
Product cost =$4+$3+$1+ $50,000/8,000
= $4+$3+$1
= $14.25 per unit
= $8 per unit
Manufacturing CGS
Inventory
Class Example Absorption vs Direct Costing
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Definition of Product CostAbsorption
CostingDirect
Costing
Product cost =$4+$3+$1+ $50,000/8,000
= $4+$3+$1
= $14.25 per unit
= $8 per unit
Manufacturing CGS
= $14.25 x 7,600
= $108,300
Inventory
Class Example Absorption vs Direct Costing
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Definition of Product CostAbsorption
CostingDirect
Costing
Product cost =$4+$3+$1+ $50,000/8,000
= $4+$3+$1
= $14.25 per unit
= $8 per unit
Manufacturing CGS
= $14.25 x 7,600
=$8 x 7,600
= $108,300 = $60,800
Inventory
Class Example Absorption vs Direct Costing
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Definition of Product CostAbsorption
CostingDirect
Costing
Product cost =$4+$3+$1+ $50,000/8,000
= $4+$3+$1
= $14.25 per unit
= $8 per unit
Manufacturing CGS
= $14.25 x 7,600
=$8 x 7,600
= $108,300 = $60,800
Inventory = $14.25 x 400
= $5,700
Class Example Absorption vs Direct Costing
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Definition of Product CostAbsorption
CostingDirect
Costing
Product cost =$4+$3+$1+ $50,000/8,000
= $4+$3+$1
= $14.25 per unit
= $8 per unit
Manufacturing CGS
= $14.25 x 7,600
=$8 x 7,600
= $108,300 = $60,800
Inventory = $14.25 x 400 = $8 x 400
= $5,700 = $3,200
Class Example Absorption vs Direct Costing
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Accounting for Fixed OH
Absorption Costing
Direct Costing
fixed OH
fixed OH
product costs
inventory in B/S, if unsoldcost of goods sold in I/S, if sold
period costs expensed in I/S in period incurred 21
Class Example -Accounting for Fixed Overhead
Absorption Costing Direct Costing
Fixed OH deducted as CGS
Fixed OH deducted as expense
Fixed OH in inventory
Class Example Absorption vs Direct Costing
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Class Example -Accounting for Fixed Overhead
Absorption Costing Direct Costing
Fixed OH deducted as CGS
Fixed OH deducted as expense
= $50,000/8,000 x 7,600
= $47,500
Fixed OH in inventory
Class Example Absorption vs Direct Costing
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Class Example -Accounting for Fixed Overhead
Absorption Costing Direct Costing
Fixed OH deducted as CGS
Fixed OH deducted as expense
= $50,000/8,000 x 7,600
= $47,500
Fixed OH in inventory
= $50,000/8,000 x 400
= $2,500
Class Example Absorption vs Direct Costing
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Class Example -Accounting for Fixed Overhead
Absorption Costing Direct Costing
Fixed OH deducted as CGS
Fixed OH deducted as expense
= $50,000/8,000 x 7,600 = $50,000
= $47,500
Fixed OH in inventory
= $50,000/8,000 x 400
= $2,500
Class Example Absorption vs Direct Costing
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Operating Income Absorption Costing
Traditional Approach Costs/Expenses classified on the basis of Cost
Function (manufacturing vs. non-manufacturing)
Direct Costing Contribution Approach Costs/Expenses classified on the basis of Cost
Behaviour (variable vs. fixed)
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Absorption Costing Income
Traditional ApproachSalesCost of goods sold (manufacturing)Gross profitsSelling, general & administrative (SG&A) expenses Operating income
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Direct Costing Income Contribution Approach
Sales
Variable costs
Variable cost of goods sold (manufacturing)
Variable SG&A expenses (nonmanufacturing)
Contribution margin
Fixed costs
Fixed manufacturing costs (manufacturing)
Fixed SG&A expenses (nonmanufacturing)
Operating income28
Contribution margin= sales – variable costs
Contribution margin ratio= contribution margin / sales
Variable cost ratio= variable cost / sales
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Income Statement
Absorption Costing(Traditional Approach)
Sales
CGS
Gross profits
SG&A expenses
Operating income
Direct Costing(Contribution
Approach)
Sales
Variable costs
Contribution margin
Fixed costs
Operating income
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Class Example -Operating Income
Absorption Costing
Sales
CGS
Gross profits
SG&A expenses
Variable SG&A
Fixed SG&A
SG&A expenses
Operating income
Direct Costing
Sales
Variable costs
Variable mfg CGS
Variable SG&A
Total variable costs
Contribution margin
Fixed costs
Fixed mfg costs
Fixed SG&A
Total fixed costs
Operating income
Class Example Absorption vs Direct Costing
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Class Example -Operating Income
Absorption Costing
Sales $152,000
CGS 108,300
Gross profits $43,700
SG&A expenses
Variable SG&A
$15,200
Fixed SG&A 15,000
SG&A expenses $30,200
Operating income
$13,500
Direct Costing
Sales
Variable costs
Variable mfg CGS
Variable SG&A
Total variable costs
Contribution margin
Fixed costs
Fixed mfg costs
Fixed SG&A
Total fixed costs
Operating income
Class Example Absorption vs Direct Costing
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Class Example -Operating Income
Absorption Costing
Sales $152,000
CGS 108,300
Gross profits $43,700
SG&A expenses
Variable SG&A
$15,200
Fixed SG&A 15,000
SG&A expenses $30,200
Operating income
$13,500
Direct Costing
Sales $152,000
Variable costs
Variable mfg CGS
$60,800
Variable SG&A 15,200
Total variable costs
$76,000
Contribution margin
$76,000
Fixed costs
Fixed mfg costs
$50,000
Fixed SG&A 15,000
Total fixed costs $65,000
Operating income $11,000
Class Example Absorption vs Direct Costing;Reconciliation of Absorption and Direct Costing Income
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Differences in Absorption & Direct Costing Income
1. If production > sales,fixed OH deferred in ending inventory under absorption costing,fixed OH deducted as cost of goods sold under absorption costing < fixed OH expensed under direct costingabsorption costing income (ACI) > direct costing income (DCI)
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Differences in Absorption & Direct Costing Income
2. If production < sales,fixed OH in beginning inventory deducted as cost of goods sold under absorption costing,fixed OH deducted as cost of goods sold under absorption costing > fixed OH expensed under direct costingabsorption costing income (ACI) < direct costing income (DCI)
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Differences in Absorption & Direct Costing Income
3. If production = sales,
absorption costing income (ACI) = direct costing income (DCI)
Assumptions:
FIFO for inventory costing.
No difference in fixed OH per unit between last and current periods.
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Timing Difference
The difference between absorption and direct costing income is temporary as it will reverse from period to period depending on the relationship between production and sales units.
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Reconciliation of Absorption and Direct Costing Income
Absorption Costing
Fixed OH
Beg. Inv.
Current Production
charged to I/S as cost of goods soldcharged to I/S as cost of goods solddeferred in end. inv. in B/S
Direct Costing Fixed OH
Current Production
expensed in I/S
X
Y
Z
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Y
Z
Absorption Costing Income (ACI)
= Income before fixed OH – X - Y
Direct Costing Income (DCI)
= Income before fixed OH – Y - Z
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Income before fixed OH
ACI + X = DCI + Z
ACI = DCI + Z - X
= ACI + X + Y (Absorption Costing)
= DCI + Y + Z (Direct Costing)
DCI = ACI + X - Z40
Reconciliation of Absorption and Direct Costing Income
Absorption Costing Income
Direct Costing
Income
= +Fixed OH in ending inventory
-
Fixed OH in
beginning
inventory
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Reconciliation of Absorption and Direct Costing Income
Direct Costing Income
Absorption Costing
Income
= -Fixed OH in ending inventory
+
Fixed OH in
beginning
inventoryClass Example:
Direct costing income = 13,500 - $2,500 – 0
= $11,000 42
Class Example -Operating Income
