Direct costing
Direct costing vs Absorption costing Income analysis under direct costing and absorption costing
Product cost
All costs incurred in getting product to saleable condition Three main elements:
Raw Materials Labor Factory overheads
Period cost
All costs incurred for a period of time regardless of production Sometimes classified into:
Marketing expenses General (administrative) expenses Financial expenses
Direct Costs
Major costs that can be directly attributable to the final product or service Includes:
Direct materials Direct labour Other: subcontractors, tender document preparation
Indirect Costs
All other costs that cannot be directly attributable to the final product or service. Includes
Indirect materials: factory supplies, small items of material Indirect labour: admin, cleaning or security staff Factory overheads; rates, rent, insurance, telephone, stationery
Fixed
costs
Those costs that in total will remain the same for a period of time and over a relevant range or output Includes:
Rent, rates, insurance, depreciation
Variable
costs
Those costs that in total will tend to increase as output level increase Includes:
Direct Materials and Direct Labour
Used for internal planning and decision making Does not include Fixed factory overhead as a product cost
Alternative
method of costing
Fixed manufacturing costs is not treated as a product cost instead it is treated as a period cost
That is, it is written off (expensed) in the period in which it is incurred rather than included as a cost when determining the cost of inventory
If fixed manufacturing costs are excluded from the cost of inventory when using direct costing then inventory at end of an accounting period will be lower than the value is using absorption costing this will effect both the balance sheet and profits
Absorption Costing
Cost of Goods Manufactured Direct Materials Direct Labor Variable Factory OH Fixed Factory OH Period Expense
Direct Costing
Faisal Manufacturing Company has no beginning inventory and sales are estimated
Total Cost Manufacturing costs: Variable $ 700,000 Fixed 400,000 Total costs $1,100,000 Selling and administrative exp. Variable ($5 per unit sold) $ 100,000 Fixed 100,000 Total expenses $ 200,000
Total Cost Manufacturing costs: Variable $ 875,000 Fixed 400,000 Total costs $1,275,000 Selling and administrative exp. Variable ($5 per unit sold) $ 100,000 Fixed 100,000 Total expenses $ 200,000
Faisal Manufacturing Company Absorption Costing Income Statements 20,000 Units 25,000 Units Manufactured Manufactured $1,500,000 $1,500,000
Sales Cost of goods sold: Cost of goods manufactured (20,000 units x $55)
$1,100,000
Faisal Manufacturing Company Absorption Costing Income Statements 20,000 Units 25,000 Units Manufactured Manufactured $1,500,000 $1,500,000
Sales Cost of goods sold: Cost of goods manufactured (20,000 units x $55) (25,000 units x $51)
$1,100,000
$1,275,000
Faisal Manufacturing Company Absorption Costing Income Statements 20,000 Units 25,000 Units Manufactured Manufactured $1,500,000 $1,500,000
Sales Cost of goods sold: Cost of goods manufactured (20,000 units x $55) (25,000 units x $51) Less ending inventory: (5,000 units x $51) Cost of goods sold Gross profit Selling and administrative expenses ($100,000 + $100,000) Income from operations
$1,100,000
$1,275,000
255,000 $1,020,000 $ 480,000 200,000 $ 280,000
Faisal Manufacturing Company Direct Costing Income Statements 20,000 Units 25,000 Units Manufactured Manufactured $1,500,000 $1,500,000
Sales Variable cost of goods sold: Variable cost of goods manufactured: (20,000 units x $35) $ 700,000 (25,000 units x $35)
$ 875,000
Faisal Manufacturing Company Direct Costing Income Statements 20,000 Units 25,000 Units Manufactured Manufactured $1,500,000 $1,500,000
Sales Variable cost of goods sold: Variable cost of goods manufactured: (20,000 units x $35) $ 700,000 (25,000 units x $35) Less ending inventory: (0 units x $35) 0 (5,000 units x $35) Variable cost of goods sold $ 700,000 Manufacturing margin $ 800,000
Continued
$ 875,000
Faisal Manufacturing Company Direct Costing Income Statements 20,000 Units 25,000 Units Manufactured Manufactured
Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Total fixed costs Income from operations
$ 800,000
100,000 $ 700,000 $ 400,000 100,000 $ 500,000 $ 200,000
$ 800,000
100,000 $ 700,000 $ 400,000 100,000 $ 500,000 $ 200,000
Sales Variable cost of goods sold: Variable cost of goods manufactured: (30,000 units x $35) Less ending inventory: (10,000 units x $35) Variable cost of goods sold Manufacturing margin
Continued
$1,500,000
Faisal Manufacturing Company Direct Costing Income Statements 30,000 Units Manufactured
Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Total fixed costs Income from operations
$ 800,000
100,000 $ 700,000 $ 400,000
Profit planning
Decision making