ABSORPTION AND VARIABLE COSTING

1. Bang Company makes state-of-the-art toy car. Each toy car sells for
P1,000 each. Data for 2016's operation are as follows:

Units: Direct Labor

Beginning Inventory 5 16,000
Production 80 Variable Factory Overhead
Ending Inventory 15 8,000
Fixed Factory Overhead
20,000
Variable Selling & Admin
Costs and Expenses: 4,000
Direct Materials Fixed Selling & Admin
P24,000 2,000
Required:
1. Determine the inventory cost per unit under:
A. Absorption costing
B. Variable costing
2. Determine the cost of ending inventory under:
A. Absorption costing
B. Variable costing
3. Prepare Income Statements under:
A. Absorption costing
B. Variable costing
4. How much is the difference in income between the two costing methods?
(Determine the difference in income without using the income between the
two costing methods)
5. What causes the difference in income between the two costing methods?

SOLUTION GUIDE to req.1

(A) Absorption Costing (B) Variable Costing

Total Per Unit Per Unit
DM
DL
VFOH
FFOH
Total

SOLUTION GUIDE to req.3

Bang Company
Income Statement for the period 2016

(A) Absorption Costing (B) Variable Costing

SALES SALES
-COST OF SALES -VARIABLE COST
GROSS PROFIT CONTRIBUTION MARGIN
-EXPENSES FIXED COST
NET INCOME PROFIT

2. The following information are taken from the books of Be Smooth

Company, which assumes first-in, first-out (FIFO) for inventory cost flow:

Inventory (in units) 2015 2016

Beg Inventory. -none- ?
Production. 10,000 units. 9,000 units
End Inventory. 3,500 units. 1,000 units

Sales (P2 per unit). ? ?

Variable Manufacturing Costs (P0.75 per unit) P7,500 P6,750
Fixed Manufacturing Costs. P5,000 P5,400
Selling & Admin Costs P4,500 P7,500

Required:
1. Determine 2015 profit under:
A. Absorption costing
B. Variable costing
2. Reconcile the two income figures in No.1
3. Determine 2016 profit under:
A. Absorption costing
B. Variable costing
4. Reconcile the two income figures in No.3

(Adapted: Cost Accounting by Horngren, et all)

SOLUTION & ANSWERS:

2015
ABSORPTION VARIABLE
SALES P13,000 SALES P13,000
CGS (8,125) VC (7,125)
GP P4,875 CM P5,875
EXP (4,500) FC (7,250)
INCOME P 375 LOSS (P1,375)

2016
ABSORPTION VARIABLE
SALES P23,000 SALES P23,000
CGS (15,175) VC (12,375)
GP P7,825 CM P10,625
EXP (7,500) FC (9,150)
INCOME P 325 PROFIT P1,475

2015:
CGS = 6,500 x P1.25 = P8,125
VC = (6,500 x P0.75) + (4,500 x 50%) = P7,125
FC = 5,000 + (4,500 x 50%) = P7,250

Reconciliation: Income = (3,500 - 0) P0.50 = P1,750 --> 375 - (-1,375)

2016:
CGS = (3,500 x P1.25) + (8,000 x P1.35) = P15,175 (using FIFO)
VC = (11,500 x P0.75) + (7,500 x 50%) = 12,375
FC = 5,400 + (7,500 x 50%) = P9,150

Reconciliation: Income = Inventory x FFOH/unit.

Beg Inventory (2014 layer) : 3,500 x P0.50 = P1,750
End Inventory (2015 layer) : 1,000 x P0.60 = (600)
P1,150 --> 1,475 - 325

EXERCISES:
1. Under absorption costing, fixed manufacturing overhead costs are best
described as
A. Direct period costs
B. Indirect period costs
C. Direct product costs
D. Indirect product costs

2. Under variable costing, fixed manufacturing overhead costs are best

described as
A. Direct period costs
B. Indirect period costs
C. Direct product costs
D. Indirect product costs

3. Determine the false statement regarding variable costing:

A. All product costs are variable.
B. All selling costs are period costs.
C. All variable costs are product costs.
D. All fixed costs are expensed in the period incurred.

Items 4 to 5 are based on the following information

White Company manufactures a single product. Unit variable production
costs are P20 and fixed production costs are P150,000. White uses a normal
activity of 10,000 units. White began the year with no inventory, produced
12,000 units and sold 7,500 units.

4. What is the unit product cost under variable costing?

A. P20.00
B. P32.50
C. P35.00
D. P40.00

5. What is the unit product cost under absorption costing?

A. P20.00
B. P32.50
C. P35.00
D. P40.00

6. What is the capacity or volume variance under absorption costing?

A. P24,000 unfavorable
B. P24,000 favorable
C. P30,000 unfavorable
D. P30,000 favorable
Note: Capacity or volume variance = (actual production - normal production)
x unit FFOH

7. (T/F) There is no volume or capacity variance under variable costing

8. If production is higher that sales, then absorption costing income is

expected to be
A. Lower than variable costing income
B. Higher than variable costing income
C. Equal to the variable costing income
D. Incomparable with variable costing income

9. Silver Company produced 10,000 units and sold 9,000 units. Fixed
manufacturing overhead costs were P20,000 and variable manufacturing
overhead costs were P3 per unit. Which of the ff best describes the net
income under the absorption costing method?
A. 2,000 more than net income under variable costing method
B. 5,000 more than net income under variable costing method
C. 2,000 less than net income under variable costing method
D. 5,000 less than net income under variable costing method

10. Pink Company has operating income of P50,000 using direct costing for
a given period. Beginning and ending inventories for that period were
13,000 units and 18,000 units, respectively. If the fixed factory overhead
application rate is P2 per unit, then what is the operating income using the
absorption costing?
A. P70,000
B. P60,000
C. P50,000
D. P40,000

11. Eighty Three Company had 16,000 units in its beginning inventory.
During the year, the company's variable production costs were P6 per unit
and its fixed manufacturing overhead costs were P4 per unit. The company's
net income for the year was P24,000 lower under absorption costing than it
was under variable costing.
How many units does the company have in its ending inventory?
A. 22,000 units
B. 10,000 units
C. 6,000 units
D. 4,000 units

12. Amethyst Bear Company had a net income of P85,500 using variable
costing and net income of P90,000 using absorption costing. Total fixed
manufacturing overhead cost was P150,000 and production was 100,000
units.
How did the inventory level change during the year?
A. 3,000 units increase
B. 4,500 units increase
C. 3,000 units decrease
D. 4,500 units decrease

13. (T/F) Under a just-in-time (JIT) production environment, income under

absorption costing tends to be equal with income under variable costing.

14. (T/F) Variable costing income fluctuates with production and does not
react to changes in sales.
15. Variable costing is unacceptable for
A. Financial reporting
B. Cost-Volume-Profit analysis
C. Transfer pricing
D. Make-or-buy decision making