Purchase Requisition Process (PR): Step-by-Step Guide 2027

Absorption Costing vs. Variable Costing: Understand fixed manufacturing overhead, product cost, inventory valuation, and profit differences with practical examples.

             

Absorption Costing vs. Variable Costing-with Practical Examples

Absorption costing:

Absorption costing means the all cost are associate with the manufacturing of the product .Some time it is called full cost of the manufacturing of the product.It included all manufacturing cost such as (Material cost+Labor cost+Variable & fixed manufacturing overhead cost) result create full cost of manufacturing of the product or abortion costing.

 Absorption costing formula is

we know that ,absorption costing per unit include :say for example

                                  Material cost per unit = 2.50

                                      Labor cost per unit = 1.50

          variable manufacturing cost per unit =1.20

      Add: Fixed manufacturing cost per unit=50

                                 (500000/10000 units)

             Result total absorption cost per unit=55.20

 Variable Costing:

 Where as, Variable Costing means the all cost are associate with the manufacturing of the product except fixed manufacturing overhead cost .Some time it is called Marginal cost of the manufacturing of the product.It included all manufacturing cost such as (Material cost+Labor cost+Variable manufacturing  overhead cost) result create variable cost of the  manufacturing of the product or Marginal  costing.

                                            Variable costing formula is

we know that ,Variable  costing per unit include :say for example

                                  Material cost per unit = 2.50

                                      Labor cost per unit = 1.50

          variable manufacturing cost per unit =1.20

                Result total Variable cost per unit=5.20

Let,s start with Practical Example

Practical Example. (01)

The wimax company LTD. manufactures & sales one product  provide following  Information

  Selected cost and operating data relating to the product for two years are given below-

                                      Selling price per unit=50

                        Direct Material cost per unit = 11

                           Direct  Labor cost per unit = 6

          variable manufacturing  cost per unit =3          

     Fixed manufacturing overhead per year =1,20,000

                              Selling & Admin expense

                                    Variable per unit sold =4

                                                 Fixed per year =70,000

                                    Production & Sales Units     Year-01           Year-02

                                                       Opening units=       0                       2000

                                     Production for the Year=     10000                  6000

                                                             units sold =      8,000                   8,000

                                                         Closing Stock=     2,000                     0

Requirement :

01 Assume the company uses absorption costing.

a. Compute Unit product cost each year

b.Prepare income statement Each year

02 Assume the company uses Variable costing costing.

a. Compute Unit product cost each year

b.Prepare income statement Each year

03.Reconcile the variable costing & absorption costing net operating income

Solution:

01.a under absorption costing per unit:

                                                                                  Year-01           Year-02

                                  Direct Material cost per unit  = 11                      11

                                       Direct  Labor cost per unit = 6                       6

                  variable manufacturing OH cost per unit =3                      3  

                   Fixed manufacturing overhead per unit =12                   20

                          (1,20,000/10000),(1,20,000/6000),

                           under absorption costing per unit   =32                     40

01.b.Under absorption costing income statement as follows

                                                                                              Year-01           Year-02

                                              Sales(8000@ 50 per unit)  = 4,00,000             4,00,000

   Cost of goods sold(8000*32), (2000*32) +(6000*40) = 2,56,000               3,04,000      

                                                              Gross margin  = 1,44,000               96,000

                                       Selling & Admin expense

                                      (8000units@4 per unit+70000) =1,02,000                1,02,000

                                                 Net operating income(loss)= 42,000                ( 6,000)

 02.a under variables costing per unit:

                                                                                  Year-01           Year-02

                                  Direct Material cost per unit  = 11                      11

                                       Direct  Labor cost per unit = 6                       6

                  variable manufacturing OH cost per unit =3                      3 

                               under variables costing per unit  =20                   20

 2.b. Under variable  costing income statement as follows

                                                                                              Year-01             Year-02

                                              Sales(8000@ 50 per unit)  = 4,00,000             4,00,000

                 Variable cost of goods sold  (8000 units*20) = (1,60,000)             (1,60,000)

       Variable   Selling & Admin expense (8000 units*4)=( 32,000)              (  32,000)

                                                         Contribution Margin= 2,08,000                2,08,000

                                                              Less Fixed expense:

                                         Fixed manufacturing overhead=(12,0,000 )           ( 1,20,000)

                                         Fixed Selling & Admin expense=(70,000)                (70,000)

                                                    Net operating income(loss)= 18,000              18,000

03. The Reconcile the variable costing & absorption costing net operating income follows

                                                                                                Year-01           Year-02

                                  Variable costing net operating income=18,000              18,000

Add: Fixed manufacturing OH  cost deferred in inventory  

        under absorption costing    (2000 units@ 12 per unit) =24,000                                                                                  

Deduct:Fixed manufacturing OH  cost released from inventory 

                                   under absorption costing (2000 units*12) =                   (24,000)

               Under absorption costing net operating  income(loss)= 42,000         ( 6,000) (Proved)

Practical Example. (02) (CMA-May-2023-Old)

The corporate practice bd LTD  sales recycles plastic product for Tk.58 per unit.Production & sales data for each of the first three months of 2023 are as follows.

Particulars	January	February	March
Sales in units(actual)	4,800	5,000	7,600
Production in units(Actual)	5,400	4,800	8,000

Budgeted cost information for each month

Product cost:

Direct Materials:2 square metres@Tk.4.20 per square meter

Direct labor:2 hours@Tk.10.25 per hour

Variable production overhead: 50% of direct labor

Actual cost information Each month:

Fixed production overhead Tk.12,000

Fixed selling overhead: Tk.22,500

Sales commission 10% on sales value

Others information

There was no opening inventory at 1 January-2023.Fixed production overhead are budgeted at TK.1,20,000 per annum,& are absorbed into products based on budgeted normal output of 60,000 units per annum.

Requirement:

01.Prepare income statement for each of three months using absorption costing principles

02.Prepare income statement for each of three months using variable(marginal) costing principles

Ans: Req-01 

Income statement for the ABC Company LTD for the Month (January to March)using absorption costing

Particulars	January		February		March
Sales(4800*58)(,(5000*58)		278000		290000		440800
Cost of sales
Opening inventory	0		24460		16460
+production(5400*41.15)	222210		197520		329200
-closing inventory	(24690)	(197520)	(16460)	(205750)	(32920)	(312740)
Under/(over absorbed) OH		1200		2400		(4000)
Gross profit		79680		81850		132060
Variable sales commission	27840		29000		44080
Fixed selling Overhead	22500	(50340)	22500	51500	22500	(66580)
Profit		29340		30350		65480

Ans: Req-02

Income statement for the ABC Company LTD for the Month (January to March) using variable costing

Particulars	January		February		March
Sales(4800*58)(,(5000*58)		278000		290000		440800
Cost of sales
Opening inventory	0		23490		15660
+production(5400*39.15)	211410		187920		313200
-closing inventory	(23490)	187920	(15660)	(195750)	(31320)	(297540)
Variable sales commission		27840		29000	44080	44080
Gross profit		62640		65250		99180
Fixed production overhead
Fixed selling Overhead	22500	(34500)	22500	34500	22500	(34500)
Profit		28140		30750		64680

Practical Example. (03)

The wimax company LTD. manufactures & sales one product  provide following  Information

  Selected cost and operating data relating to the product for two years are given below-

                                      Selling price per unit=60

                        Direct Material cost per unit = 7

                           Direct  Labor cost per unit = 10

          variable manufacturing  cost per unit =5        

     Fixed manufacturing overhead per year =315000

                              Selling & Admin expense

                                    Variable per unit sold =3

                                                 Fixed per year =245000

                                    Production & Sales Units          July                 August

                                                       Opening units=       0                     2500

                                     Production for the Year=     17500                 17500

                                                             units sold =      15000               20000

                                                         Closing Stock=     2,500                    0

 The company the Accounting Department  has prepared absorption costing Income statement for July -August is presented below

                                                                                   July                      August

                                                           sales         =  9,00,000              12,00,000

                                            Cost of good sold   =  6,00,000              8,00,000

                                                    Gross margin =  3,00,000               4,00,000

                                    Selling &admin expense = 2,90,000               30,5,000

                                       Net operating income =10,000                     95,000

Requirement :

01 Assume the company uses absorption costing.

a. Compute Unit product cost each year

b.Prepare income statement Each year

02 Assume the company uses Variable costing costing.

a. Compute Unit product cost each year

b.Prepare income statement Each year

03.Reconcile the variable costing & absorption costing net operating income

 04.The company Accounting department determine the BEP=(Fixed cost /Unit c.m )

                                                                                                        =560000/35 per unit

                                                                                                         = 16000 units

****It is notice that in July sales only 15,000 units & Net operating income =10,000, how it is possible  where BEP sales in July 16,000 units by the Accounting Department ,is accounting department calculation is wrong or not *** Describe your own analysis....

Solution: ***(Try yourself)****

Frequently Asked Questions(FAQs)

Q1. What is Absorption Costing?
Absorption costing is a product costing method that includes direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead in the cost of a product.

Q2. What is the difference between Absorption Costing and Variable Costing?
The main difference is the treatment of fixed manufacturing overhead. Absorption costing includes fixed manufacturing overhead in product cost, while variable costing treats it as a period expense.

Q3. How is Absorption Costing calculated?
Absorption cost per unit is generally calculated by adding direct materials, direct labor, variable manufacturing overhead, and allocated fixed manufacturing overhead, then determining the cost per unit produced.

Q4. Why can profit differ under Absorption Costing and Variable Costing?
Profit can differ when production and sales volumes are different because absorption costing carries a portion of fixed manufacturing overhead in ending inventory, whereas variable costing expenses fixed manufacturing overhead in the current period.