Variable Costing and Full

Costing

Slide 5-1

Full
Full (Absorption)
(Absorption) Costing
Costing
Required by GAAP for external reporting
purposes
Inventory costs include:

Direct materials used

Direct labor incurred

Generally variable

Manufacturing overhead

Slide 5-2

Generally variable

Includes both fixed and variable costs

Learning objective 1: Explain the difference

between full (absorption) and variable costing

Variable
Variable Costing
Costing
Inventory costs includes:
Direct materials used
Direct labor incurred
Variable manufacturing overhead

Fixed manufacturing overhead treated

as a period cost
Helpful for internal decision making
Not allowed for GAAP reporting

Slide 5-3

Learning objective 1: Explain the difference

between full (absorption) and variable costing

Difference
Difference Between
Between Full
Full and
and
Variable
Variable Costing
Costing
The only difference between full and
variable costing is their treatment of
fixed manufacturing overhead
Under full costing, fixed manufacturing
overhead is included in inventory
These costs enter into the determination of
expense only when the inventory is sold

Under variable costing, fixed

manufacturing overhead becomes a
period expense
Slide 5-4

Learning objective 1: Explain the difference

between full (absorption) and variable costing

Variable
Variable Costing
Costing Income
Income
Statement
Statement
Classifies all expenses in terms of their
cost behavior, either fixed or variable
With variable and fixed expenses
separated, the contribution margin can be
presented
Contribution margin is revenues minus total
variable expenses

The contribution margin allows users to

make reasonable estimates of how much
profit will change with changes in sales

Slide 5-5

Learning objective 2: Prepare an

income statement using variable costing.

Variable
Variable Costing
Costing Income
Income
Statement
Statement Example
Example

Slide 5-6

Learning objective 2: Prepare an

income statement using variable costing.

Full
Full Costing
Costing Income
Income Statement
Statement
Example
Example

Slide 5-7

Learning objective 2: Prepare an

income statement using variable costing.

Variable
Variable Costing
Costing vs.
vs. Full
Full
Costing
Costing Income
Income Statement
Statement
The full costing income statement
cannot be used to estimate the increase
in profit due to an increase in sales
The reason is that cost of goods sold
includes both fixed and variable costs
The fixed costs will not increase when
sales increase
Under full costing we do not know how
much of cost of goods sold is fixed or
variable
Slide 5-8

Learning objective 2: Prepare an

income statement using variable costing.

Example
Example -- Clausen
Clausen Tube
Tube
Selling price $2,000
Variable costs (per unit):
Materials = $600/unit
Labor = $225/unit
Variable mfg. overhead = $75/unit
Variable selling expense = $40/unit
Fixed mfg. overhead = $1,200,000
Production = 5,000 units

Slide 5-9

Learning objective 3: Discuss the effect of

production on full and variable costing income.

Clausen
Clausen Tube
Tube
Full
Full Cost
Cost per
per Unit
Unit
Full cost per unit for 5,000 units is
calculated as follows:
Total Material Costs

$600 per unit

Total labor costs

$225 per unit

Total variable OH
Fixed Overhead
Full Cost per Unit

Slide 5-10

$75 per unit

$1,200,000/5,000
units

$240 per unit

= $1,140 per unit

Learning objective 3: Discuss the effect of

production on full and variable costing income.

Clausen
Clausen Tube
Tube
Variable
Variable Cost
Cost per
per Unit
Unit
Variable cost per unit for 5,000 units is
calculated as follows:
Total Material Costs

$600 per unit

Total labor costs

$225 per unit

Total variable OH
Variable Cost per Unit

Slide 5-11

$75 per unit

= $900 per unit

Learning objective 3: Discuss the effect of

production on full and variable costing income.

Clausen
Clausen Tube
Tube
Income
Income
Statement
Statement

Slide 5-12

Selling price = $2,000/unit

Full cost = $1,140/unit
Variable cost = $900/unit
Variable selling expense = $40/unit
Fixed overhead = $1,200,000
Fixed selling expense = $100,000
Fixed administrative expense= $500,000

Learning objective 3: Discuss the effect of

production on full and variable costing income.

Clausen
Clausen Tube
Tube
Income
Income
Statements
Statements
Production equals sales (5,000 units)

Slide 5-13

Learning objective 3: Discuss the effect of

production on full and variable costing income.

Quantity
Quantity Produced
Produced Equals
Equals
Quantity
Quantity Sold
Sold
When the quantity produced equals the
quantity sold, there is no difference
between net income calculated using full
cost versus variable costing
Since all units produced are sold, no fixed
cost ends up in ending inventory
The only difference is that variable costing
calculates the contribution margin

Slide 5-14

Learning objective 3: Discuss the effect of

production on full and variable costing income.

Clausen
Clausen Tube
Tube
Income
Income
Statements
Statements
Production (6,000 units) is greater than
sales (4,800 units)

Slide 5-15

Learning objective 3: Discuss the effect of

production on full and variable costing income.

Quantity
Quantity Produced
Produced is
is Greater
Greater
Than
Than Quantity Sold
When the quantity produced is greater
than the quantity sold income will be
greater under full costing as opposed to
variable costing
Under full costing, inventory cost includes
fixed manufacturing overhead
Under variable costing, fixed
manufacturing overhead is a period cost

Slide 5-16

Learning objective 3: Discuss the effect of

production on full and variable costing income.

Clausen
Clausen Tube
Tube
Income
Income
Statements
Statements
Production (6,000 units) is less than sales
(7,200 units)

Slide 5-17

Learning objective 3: Discuss the effect of

production on full and variable costing income.

Quantity
Quantity Produced
Produced is
is Less
Less
Than
Than Quantity Sold
Then the quantity produced is less than the
quantity sold, income will be greater under
variable costing as opposed to full costing
Beginning inventory under fixed costing
includes fixed manufacturing overhead
When the beginning inventory is charged to
cost of goods sold the charge will be higher
under full costing

Slide 5-18

Learning objective 3: Discuss the effect of

production on full and variable costing income.

Impact
Impact of
of Method
Method Selection
Selection on
on
Income
Income Statement
Statement
Units produced = units sold
No difference in net income

Units produced greater than units sold

Full costing yields higher net income

Units Produced less than units sold

Variable costing yields higher net
income

Slide 5-19

Learning objective 3: Discuss the effect of

production on full and variable costing income.

Benefits
Benefits of
of Variable
Variable Costing
Costing for
for
Internal
Internal Reporting
Reporting
Variable costing facilitates costvolume-profit (CVP) analysis
Separates fixed and variable costs
Allows managers to accurately
estimate the impact of changes in
volume on cost and profit
Cannot be answered using full costing

Slide 5-20

Learning objective 5: Discuss the benefits of

variable costing for internal reporting purposes