VARIABLE COSTING

Group 6 :
Rin Nabil Febrais (1710532013)
Afdhallur Rijal (1710532063)
Masyitah Hiyasari (1710533039)
Defenition Variable Costing and the
Difference Between Absorption and
Variable Costing
 About Variable Costing

1. Variable Costing includes:

a. Direct material
b. Direct labor
c. Variable Manufacturing overhead

2. Variable Costing lends itself well to decision

making and “what-if” analyses.
3. Not allowed for GAAP.
 About Full (Absorption) Costing

1. Full (Absorption) Costing includes:

a. Direct material
b. Direct labor
c. Manufacturing overhead (both variable and fixed)
2. Decision making and “what-if” decisions are difficult
because of the commingling of fixed and variable
overhead.
3. Required for GAAP.
 Difference Variable and Absorption Costing

1. Fixed manufacturing overhead (included in Full

Costing).
2. Fixed manufacturing costs, like depreciation, are a
period expense on the income statement under
variable costing.
3. Fixed manufacturing costs, like depreciation, are
inventoried until sold under full costing.
 Manager Use Variable Costing in
Financial Reporting

In order To :
1. Conduct break-even analysis to determine the number of units
needed to be sold to begin earning a profit
2. Determine the contribution margin on a product, which helps to
understand the relationship between cost, volume, and profit.
Facilitate decision-making by excluding fixed manufacturing
overhead costs, which can create problems due to how fixed costs
are allocated to each product
Income Statement Using Variable
Costing
 Income Statements Using Variable and
Absorption Costing

Because unit product costs are the basis for cost of

goods sold, the variable- and absorption-costing
methods can lead to different operating income figures.
The difference arises because of the amount of fixed
overhead recognized as an expense under the two
methods.
Value of ending inventory
Effect of Production on Full and
Variable Costing Income
 Effects of Production on Income for Full Versus
Variable Costing: Clausen Tube

Facts:
 5,000 units produced and sold
 Selling Price: $2,000 per unit
 Variable Manufacturing:
 Direct Materials: $600 per unit
 Direct Labor: $225 per unit
 Variable MFG: $75 per unit
 Fixed Manufacturing: $1,200,000 per year
 Selling Expense: $40 per unit variable plus $100,000 fixed.
 Administrative: $500,000 per year (fixed)
 Clausen Tube Income Statement: Full Costing

Sales $10,000,000
Less COGS 5,700,000
Gross Margin 4,300,000
Less Selling and Admin:
Selling $300,000
Admin 500,000 800,000
Net Income $3,500,000
 Clausen Tube Income Statement: Variable Costing

Sales $10,000,000
Less Variable:
Variable COGS 4,500,000
Variable Selling
and Admin 200,000 $4,700,000
Contribution Margin $5,300,000
Less Fixed:
Fixed Mfg. 1,200,000
Fixed Selling 100,000
Fixed Admin 500,000 1,800,000
Net Income $3,500,000
 Variable Costing Income Statement:
Considerations

1. When sales volume and production volume are exactly equal,

net income is the same under either full or variable costing.
2. Contribution margin is easily calculated under variable
costing: 2,000 – 940* = 1,060.
3. Contribution margin ratio is: 1,060 / 2,000 = 53%

* Direct Materials:$600 per unit

Direct Labor: $225 per unit
Variable MFG: $75 per unit
Selling Expense: $40 per unit variable
$900 per unit
 Summary of Effects of Production on Net Income

 If units produced = units sold,

then no difference between full costing and variable
costing net income.
 If units produced > units sold,
then full costing net income is greater than variable
costing net income.
 If units produced < units sold,
then full costing net income is less than variable
costing net income.
Advantages Disadvantages and
Limitations of Variable Costing
System
 Advantages of Variable Costing System:

 The data that are required for cost volume profit (CVP) analysis can

be taken directly from a variable costing format income statement.

These data are not available on a conventional income statement

based on absorption costing.

 Under variable costing, the profit for a period is not affected by

changes in inventories. Other things remaining the same (i.e. selling

prices, costs, sales mix, etc.), profits move in the same direction as

sales when variable costing is in use.

 Advantages of Variable Costing System:

 Managers often assume that unit product costs are variable costs.
This is a problem under absorption costing, since unit product
costs are a combination of both fixed and variable costs. Under
variable costing, unit product costs do not contain fixed costs.

 The impact of fixed costs on profits is emphasized under the

variable costing and contribution approach. The total amount of
fixed costs appears explicitly on the income statement. Under
absorption, the fixed costs are mingled together with the variable
costs and are buried in cost of goods sold and in ending
inventories.
 Advantages of Variable Costing System:

 Variable costing data make it easier to estimate the profitability of products,

customers, and other segments of the business. With absorption costing,

profitability is obscured by arbitrary allocations of fixed costs.

 Variable costing ties in with cost control methods such as standard costs and

flexible budgets.

 Variable costing net operating income is closer to net cash flow than absorption

costing net operating income. This is particularly important for companies

having cash flow problems.

 Disadvantages of Variable Costing System:

Advocates of absorption costing argue that all manufacturing costs must be assigned
to products in order to properly match the costs of producing units of product with
the revenues from the units when they are sold. The fixed costs of depreciation, taxes,
insurance, supervisory, salaries, and so on, are just as essential to manufacturing
products as are the variable costs. Advocates of variable costing argue that fixed
manufacturing costs are not really the costs of any particular unit of product. These
costs are incurred to have the capacity to make products during a particular period
and will be incurred even if nothing is made during the period.
 Disadvantages of Variable Costing System:

Moreover, whether a unit is made or not, the fixed manufacturing cost will be
exactly the same. Therefore, variable costing advocates argue that fixed
manufacturing costs are not part of the costs of producing a particular unit of
product and thus the matching principle dictates that fixed manufacturing costs
should be charged to the current period. At any rate, absorption costing is the
generally accepted method for preparing mandatory external financial reporting
and income tax returns. Probably because of the cost and possible confusion of
maintaining two separate costing systems-one for external reporting and one for
internal reporting-most companies use absorption costing for both external and
internal reports.
 Limitations of Variable Costing

A company that attempts to use variable costing (also

called direct costing and marginal costing) on its external
financial reports runs the risk that its auditors may not
accepts the financial statements as conforming
to generally accepted accounting principles (GAAP).
Tax laws almost all over the world require the usage of a
form of absorption costing for filling out income tax forms.
 Limitations of Variable Costing

Even if a company must use absorption costing for its external

reports, a manager can use variable costing statements for internal
reports. No particular accounting problems are created by using
both costing methods--the variable costing method for internal
reports and the absorption costing method for external reports. The
adjustment from variable costing net operating income to
absorption costing net operating income is a simple one that can
be easily made at year-end.
Top executives are typically evaluated based on the earnings
reported to shareholders on the external financial reports. This
creates a problem for top executives who might otherwise favor
using variable costing for internal reports. They may feel that
since they are evaluated based on absorption costing reports,
decisions should also be based on absorption costing data.
Thank You. Any Question ?