1. Variable and Full Costing ACG 4361 1-2 Prepared by Diane Tanner
University of North Florida
1-2

2. Measuring Product Costs
Two methods to measure product costs
Full (absorption) costing
Emphasizes the cost function
Product vs. period
Required for GAAP reporting
Based on the premise that inventory includes all costs necessary to get products ready to sell
Variable costing
Emphasizes cost behavior
Variable vs. fixed
Enhances internal decision making
Predicting costs is much easier

3. Comparing the Two Income Statement Formats
PRODUCT COSTS
Variable manufacturing costs (Direct materials, direct labor, variable manufacturing overhead)
Fixed manufacturing overhead
Full Absorption Costing Format
Sales (10,000 units)
$100,000
Cost of goods sold
33,000
Gross margin (gross profit)
67,000
Operating expenses
57,000
Net operating income
$ 10,000
SG&A
PERIOD COSTS
Variable selling, general and administrative costs
Fixed selling, general and administrative costs
Variable Costing Format
Sales (10,000 units)
$100,000
Variable costs
60,000
Contribution margin
40,000
Fixed costs
30,000
Net operating income
$10,000
VARIABLE COSTS
Product (manufacturing costs)
Period (operating costs)
FIXED COSTS
Product (manufacturing costs)
Period (operating costs)

4. Key Figures - Absorption Costing Income Statement
Sales (10,000 units)
$100,000
Cost of goods sold
33,000
Gross margin (gross profit)
67,000
Operating expenses
57,000
Net operating income
$ 10,000
Total gross margin
The company generated $67,000 to cover its operating expenses and to contribute to profit.
Gross margin per unit
The company generated $6.70 for each unit sold to cover its operating expenses and contribute to profit.
$67,000
10,000
Gross margin
Units =
= $6.70 per unit
Gross margin ratio
67 cents out of each sales dollar is available to cover operating expenses and to contribute to profit.
$67,000
$100,000
Gross margin
Sales =
= 67.00%

5. Key Figures - Variable Costing Income Statement
Sales (10,000 units)
$100,000
Variable costs
60,000
Contribution margin
40,000
Fixed costs
30,000
Net operating income
$10,000
Total contribution margin
The company generated $40,000 to cover its fixed costs and to contribute to profit.
Contribution margin per unit
The company generated $4.00 for each unit sold to cover its fixed costs and to contribute to profit.
$40,000
10,000
Contribution margin
Units =
= $4.00 per unit
Contribution margin ratio
40 cents out of each sales dollar is available to cover fixed costs and to contribute to profit.
$40,000
$100,000
Contribution margin
Sales =
= 40.00%

6. Expanded Absorption Costing Income Statement
Sales
$100,000
Cost of goods sold:
Variable mfg. costs
$22,000
Fixed mfg. costs
11,000
Total cost of goods sold
33,000
Gross margin (gross profit)
67,000
Operating expenses:
Variable operating costs
38,000
Fixed operating costs
19,000
Total operating expenses
57,000
Net operating income
$10,000
PRODUCT COSTS
Direct materials
Direct labor
Variable mfg overhead
Fixed mfg overhead
PERIOD COSTS
Under absorption costing, product costs consist of both variable and fixed manufacturing costs.

7. Expanded Variable Costing Income Statement
Sales
$100,000
Variable costs:
Variable mfg costs
$22,000
Variable operating costs
38,000
Total variable costs
60,000
Contribution margin
40,000
Fixed expenses:
Fixed mfg costs
11,000
Fixed operating costs
19,000
Total fixed expenses
30,000
Net operating income
$10,000
PRODUCT COSTS
Direct materials
Direct labor
Variable mfg overhead
PERIOD COSTS
Under varible costing, product costs consist of only variable manufacturing costs.

8. Timing Issues of Variable and Full Costing
Operating income and inventory amounts will differ under variable and full costing when the number of units sold differs from units produced.
Because fixed MOH costs are capitalized under full costing and expensed when incurred under variable costing.
Full Costing
Fixed manufacturing costs are attached to inventory items and expensed when units are sold (treated as product costs.)
Variable Costing
Fixed manufacturing costs are expensed when incurred (treated as period costs.)

9. Variable and Full Costing Income and Inventory Differences
Inventory levels do not change
Fixed overhead expensed is the same under both methods
Operating income is the same under both methods
When production volume = sales volume
Inventory levels increase
Fixed overhead expensed is less under absorption costing
Operating income is greater under absorption costing
When production volume > sales volume
Inventory levels decrease
Fixed overhead expensed is greater under absorption costing
Operating income is less under absorption costing
When production volume < sales volume

10. Variable Income Statement Example
Sando produced 300 stools and sold 250 of them for $33 each in May. At the beginning of May, it had 26 stools on hand. The following costs are available for Sando:
Direct materials cost per unit
$ 4.00
Variable factory overhead cost per unit
 $1.90
Total fixed administrative cost
    1,800
Variable administrative cost per unit
2.25
Direct labor cost per unit
  3.30
Total fixed production overhead cost
2,040
Sales (250 × $33)
$8,250
Variable costs:
Variable mfg costs [250 × ($ $ $1.90)]
$2,300
Variable operating costs (250 × $2.25)
563
2,863
Contribution margin
5,388
Fixed expenses:
Fixed mfg costs
2,040
Fixed operating costs
1,800
3,840
Net operating income
$1,548

11. Absorption Income Statement Example
Sando produced 300 stools and sold 250 of them for $33 each in May. At the beginning of May, it had 26 stools on hand. The following costs are available for Sando:
$2,040 ÷ 300 = $6.80
Direct materials cost per unit
$ 4.00
Variable factory overhead cost per unit
 $1.90
Total fixed administrative cost
    1,800
Variable administrative cost per unit
2.25
Direct labor cost per unit
  3.30
Total fixed production overhead cost
2,040
Sales (250 × $33)
$8,250
Cost of goods sold:
Variable mfg costs [250 × ($ $ $1.90)]
$2,300
Fixed mfg costs ($6.80 × 250)
1,700
4,000
Gross margin
4,250
Operating expenses:
Variable operating costs (250 × $2.25)
563
Fixed operating costs
1,800
2,363
Net operating income
$1,887

12. Reconciling Full and Variable Costing Income
When production volume is greater than sales volume
The FOH expensed under variable costing is greater than under absorption costing
Operating income is greater under absorption costing.
When production volume is less than sales volume
The FOH expensed under variable costing is less than under absorption costing
Operating income is greater under variable costing.

13. Reconciling Full and Variable Costing Income
When production volume is greater than sales volume
Variable operating income
+ (Change in inventory units × FOH/unit)
= Absorption operating income
When production volume is less than sales volume
― (Change in inventory units × FOH/unit)

14. Reconciliation Example
Sando produced 300 and sold 250 stools for $33 each in May. At the beginning of May, it had 26 stools on hand. Relevant costs are:
Total fixed production overhead cost
$2,040
Operating income under variable costing is $1,548. Prepare a reconciliation in good form.
Fixed overhead cost per unit: $2,040 / 300 units = $6.80 per unit
Change in finished units:
Finish Goods in Units 26
Increase from 26 to 76, or an
increase of 50 units.
300
250 76
Reconciliation:
Net operating income under variable costing
$1,548
Fixed mfg cost retained in inventory (50 × $6.80)
340
Net operating income under absorption costing
$1,888

15. Ethical Concerns of Absorption Costing
Managers are able to manipulate income under absorption costing by producing more or fewer units
Absorption costing encourages managers to engage in gaming behavior in an attempt to modify the income statement
Producing more units spreads the fixed overhead cost over more units, reducing the cost per unit
 Net income is larger
By tying up money in inventory, resources are not used efficiently
Managers tend to manage in the manner that will best impact their bonuses.
Producing more units even though sales is static increases a manager’s bonus.

16. Managing Income Example
Sando sold 250 stools for $33 each in May. At the beginning of May, it had 26 stools on hand.
Variable mfg cost per unit
$ 9.20
Total fixed mfg overhead cost
$2,040
Total fixed administrative cost
    1,800
Variable administrative cost per unit
2.25
Gross margin if 300 stools are produced.
Sales (250 × $33)
$8,250
Cost of goods sold:
Variable mfg costs (250 × $9.20)
$2,300
Fixed mfg costs ($6.80 × 250)
1,700
4,000
Gross margin
$4,250
Profit is $425 more when 100 extra units are produced.
Gross margin if 400 stools are produced.
New FOH cost per unit: $2,040 / 400 = $5.10
Sales (250 × $33)
$8,250
Cost of goods sold:
Variable mfg costs (250 × $9.20)
$2,300
Fixed mfg costs ($5.10 × 250)
1,275
3,575
Gross margin
$4,675

17. The End