Absorption and Variable Costing (Purpose of costing ( Value inventory, …
Absorption and Variable Costing
Purpose of costing
Performance measurement / control
Aim of absorption costing is to determine the full manufacturing cost per unit
Assigns production overhead costs to units by using the most suitable overhead absorption rate
Opening and closing inventories are valued at full production cost and include a share of fixed costs.
Non-manufacturing applied directly to the profit statement and exclude from inventory valuation
Selling and distribution expenses
A system of accounting for costs in which both fixed and variable costs are considered product costs
Need to attribute the manufacturing overhead to each unit
Absorption costing assumes overhead expenditure is connected to the volume produced
Use a suitable method
Overhead absorption rate = Budgeted overhead/ Budgeted Volume
Under/over recovery of overhead is regarded as a period cost and written off to the profit and loss statement and not allocated to products.
Under absorbed overhead
When the absorption rate is higher than the actual rate
Therefore, not enough manufacturing cost is charged. So this must be put in the statement of profit or loss
Over absorbed overhead
When the absorption rate is lower than the amount produced
Therefore, too much manufacturing cost is charged. So this must be subtracted from the statement of profit or loss
Assigns variable costs only to products and includes in the inventory valuation
Fixed overheads are not included in the product cost
Fixed costs of the period are not allocated to the product and are charged directly to profit.
A contribution is calculated
Difference between sales value and variable cost of sales.
Contribution towards fixed overheads and making a profit
Reconciling and difference between the systems
In both systems, non-manufacturing costs are treated as period costs and not assigned to products for inventory valuation.
The difference occurs when fixed mfg overhead should be regarded as a period cost or a product cost.
Marginal costing profit - adjust for fixed o/h in inventory = absorption costing profit
Choice depends on the impact each system has on profit measurement and inventory valuation.
Consistency is important for external reporting and performance monitoring purposes
Most meaningful for management decisions.