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Profit Reporting under Variable Costing and Absorption Costing - Coggle…
Profit Reporting under Variable Costing and Absorption Costing
Overview of variable of absorption costing
Variable costing
Fixed production costs
are
treated as period costs
and
written off
against profit
in variable costing
Variable costing
is a
simpler method
than absorption costing
In variable costing
, the
cost per unit is calculated as
:star:
direct material + direct labour + variable overheads per unit
NB!!
:star: Revenue from each
unit sold pays for fixed costs
:star:
Profit= Total Contribution
(sales revenue minus variable costs)
-
fixed costs
How is it different
Fixed overhead costs
are not allocated to units, so changes in production volume do not affect the cost per unit.
Absorption Costing
Absorption costing
is a method used by companies
to determine the full production cost of a unit.
and
indirect costs
machinery
rent
electricity
includes
direct costs
wages
materials
How is it different
NB!!
included in the
cost of each unit
is
Direct material
Direct Labor
variable overhead
:star:
fixed overhead costs
:star:
Fixed overhead costs
are allocated to units
based on a predetermined overhead rate
Includes all manufacturing costs, including fixed overhead costs
,
in the cost per unit of production
.
Unit Cost Calculation
Absorption Cost
Here is an example of how to
calculate the unit cost under absorption costing
1.)
Assume that a company
produces 10,000 units of a product in a month
, and
incurs the following costs
Variable manufacturing overhead
: $10,000
:star:
Fixed manufacturing overhead
: $20,000
Also Known as
:star:Overhead absorption rate
:star:
Overhead absorption rate
is a
predetermined rate
used
to allocate :star:Fixed Manufacturing overhead costs to
products or services produced
1.) To calculate the overhead absorption rate
1.)
the company first
estimates the total amount of fixed manufacturing overhead
costs for the period;
such as
4 more items...
2.)
The
total fixed manufacturing overhead cost
is then
divided
by an
estimated level of activity for the period
, such as:
2 more items...
Example
2 more items...
Direct labor cost
: $30,000
Total manufacturing costs
: $110,000
Direct materials cost
: $50,000
2.)
To calculate the
unit cost under absorption costing
,
follow these steps
:
i.
Calculate the
Total Manufacturing Cost per Unit:
Variable manufacturing overhead
per unit = $10,000 / 10,000 =
$1 per unit
Fixed manufacturing overhead
per unit = $20,000 / 10,000 =
$2 per unit
Direct labor cost
per unit = $30,000 / 10,000 =
$3 per unit
Total manufacturing cost per unit = $5 + $3 + $1 + $2 =
$11 per unit
Direct materials cost
per unit = $50,000 / 10,000 =
$5 per unit
ii.
Add any other costs
that are not included in the manufacturing cost per unit,
such as selling and administrative expenses
, to get the total cost per unit.
For example,
if the company
has $5,000 in selling and administrative expenses
in the month, the
total cost per unit
would be:
Total cost per unit
= $11 + ($5,000 / 10,000) =
$11.50 per unit
Variable Cost
Variable costing
is a method of costing that
includes only variable costs in the calculation
of the cost of a product
vary with
changes in production
or
sales volume
, such as
direct labour
variable overhead
direct materials
NB!!
Fixed costs
, on the other hand, are
not included in the unit cost calculation.
The
formula for calculating the unit cost
using variable costing is:
Unit Cost =
Direct Materials
+
Direct Labour
+
Variable Overhead
Broken Down Components
Direct Labour
:warning:
Direct Labor per Unit
=
Total Direct Labor Cost
/
Total Units Produced
Variable Overhead
:warning:
Variable Overhead per Unit
=
Total Variable Overhead Cost
/
Total Units Produced
Direct Materials
:warning:
Direct Materials per Unit
=
Total Direct Materials Cost
/
Total Units Produced
:warning:
Total Unit Cost
=
Direct Materials per Unit
+
Direct Labor per Unit
+
Variable Overhead per Unit
Profit Comparison of Absorption and Variable Costing
Effect of Changes in Production on Profit
Production
doesn't
always
equal sales
However, when
production equals sales
there's no change in inventories, and all
current fixed manufacturing overhead
will
flow through to the statement of profit or loss.
If
production exceeds sales
Some of the
current fixed manufacturing overhead costs
will be
deferred in inventories
.
and the
operating profit reported under absorption costing
will be
greater than
under variable costing.
This is because
under absorption costing
, fixed manufacturing overhead costs
are allocated to units produced
and
included in the cost of goods sold
while
under variable costing
, fixed manufacturing overhead costs
are expensed as period costs and are not included in the cost of goods sold
As a result, the
cost of goods sold under absorption costing will be higher than under variable costing
, which leads to a higher operating profit under absorption costing.
If
sales exceed production
some of the
fixed manufacturing overhead costs
that had been
deferred in inventories in previous periods
will be
released to the statement of profit or loss
as
a charge against profit
And the
operating profit reported under absorption costing will be less than
under variable costing
Over an extended period of time
the
cumulative operating profit figures
reported under absorption costing and variable costing
will be about the same
.
V
ariable costing
operating profit is
not affected by changes in production volume
while
absorption costing
operating profit
is affected by changes in production volume
Summary
If
production is greater than sales
inventories will increase
, and
absorption profit will be greater
than variable profit.
If
sales are greater than production
inventories will decrease
, and
absorption profit will be less
than variable profit.
Advantages And Disadvantages
Absorption Costing
Advantages
Helps
calculate profitability
of products
Helps in
budgeting
Helps
determine actual cost of production
Disadvantages
May
lead to overproduction
Ignores variable costs
Can r
esult in inaccurate cost allocation
Variable Costing
Advantages
Helps in decision making
Improved cost control
Accurate measurement of costs
:
Easy to understand
Better inventory valuation
Disadvantages
Overlooks fixed cost
s
Difficult to allocate overheads
Does not comply with GAAP
May
not reflect long-term costs
Not suitable for long-term planning