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Variable vs Absorption Costing - Coggle Diagram
Variable vs Absorption Costing
Intro
Absorption costing
conventional format
for external reporting
seggregates cost according to function
Variable costing
contribution format
for internal reporting
behavior
Additional
Throughput costing (super variable costing)
intended for theory of constraints
RM is the only product cost
Super absorption costing
Manufacturing and non-manufacturing are product cost as long as value added
for life cycle constraints
Distinction between product cost and period cost
Distinction
Product cost
inventoried when incurred and will only be charged against revenue only at the point of sale
once incurred = x expense, asset muna in the form of FG
associating cost and effect principle (something should happen for it to be chargeable to revenue)
can be deferred in inventory when P>S, and released when S>P
Period cost
once incurred = outright expense regardless of sold/produced
immediate recognition principle
cannot be deferred in inventory
Inventory costs between variable costing and absorption costing
As to operating income and inventory levels
P = S
AC = VC
END = BEG
P > S
AC > VC
END > BEG
P < S
AC < VC
END < BEG
Rationale
Absorption costing - for external report, anything related to production cost should form part of ending inventories
Variable costing - FOH is incurred whether there is or there's no production
Revenue drivers - will affect net income
Variable costing
unit level of sales (VC x units sold)
Absorption costing
unit level of sales
unit level of production (TMC/ no. of units produced)
chosen denominator level
allocation based of overhead
affects FOH per unit
added to TMC above
Performance issues in absorption costing
producing too many units resulting more fixed cost being capitalized as inventory: increase in inventory = more profit = more manager's bonus and can cause manipulation
Other manipulation scheme beyond simple overproduction
manufacture products that absorbs the highest amount of FC regardless of demand (cherry picking)
deferring period cost
keep on accepting orders, P>S = increase AC income
note: under variable costing, increase in inventory does not affect bonus/operating income because its only driver is units sold
Management countermeasure for fixed cost manipulation scheme
use variable costing
longer period of time to evaluate performance, because in the entire life of the business, if you total it, VC NI = AC NI. Fixed overhead is only a matter of time, FOH will be deducted to revenue eventually
careful budgeting and inventory planning
internal carrying charge for inventory (pag nag build up inventory)
include non financial and financial variable in performance evaluation
Selling and admin expense
if selling only = based on units sold
if selling and admin = based on units sold, but usually total amount na yan
if admin only = based on units produced x selling price, bc admin expense is already incurred even before sold
Nature and treatment of fixed factory overhead cost
Treatment of FOH
Variable = outright expense, period cost
absorption costing = essential in production process, it must comply with standards
Capacity levels for allocation of FOH
Theoretical capacity
100% capacity
perfect
modern (efficiency)
usually for production variances
Practical capacity
there's allowance for downtimes/rest periods
under traditional accounting system
standards related for disbursement of money
Normal capacity
average 3-5 years period of time that satisfies customer demand
same units within the average year
Master budget capacity
manager's expectation for the current period
based on units produced in the current year (forecasted sales)
mas maganda raw gamitin
Four cost system
Actual cost system (most common)
AP x AQ for materials, labor, and OH
Normal cost system
AP x AQ for materials and labor
AP x SQ for OH
Extended normal cost system or Flexible budget
AQ x SP for material, labor, and OH
Standard cost system or Static Budget
SP x SQ for materials labor and OH