7.6: Chapter 6 Key Points
- Page ID
- 65736
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\(\newcommand{\avec}{\mathbf a}\) \(\newcommand{\bvec}{\mathbf b}\) \(\newcommand{\cvec}{\mathbf c}\) \(\newcommand{\dvec}{\mathbf d}\) \(\newcommand{\dtil}{\widetilde{\mathbf d}}\) \(\newcommand{\evec}{\mathbf e}\) \(\newcommand{\fvec}{\mathbf f}\) \(\newcommand{\nvec}{\mathbf n}\) \(\newcommand{\pvec}{\mathbf p}\) \(\newcommand{\qvec}{\mathbf q}\) \(\newcommand{\svec}{\mathbf s}\) \(\newcommand{\tvec}{\mathbf t}\) \(\newcommand{\uvec}{\mathbf u}\) \(\newcommand{\vvec}{\mathbf v}\) \(\newcommand{\wvec}{\mathbf w}\) \(\newcommand{\xvec}{\mathbf x}\) \(\newcommand{\yvec}{\mathbf y}\) \(\newcommand{\zvec}{\mathbf z}\) \(\newcommand{\rvec}{\mathbf r}\) \(\newcommand{\mvec}{\mathbf m}\) \(\newcommand{\zerovec}{\mathbf 0}\) \(\newcommand{\onevec}{\mathbf 1}\) \(\newcommand{\real}{\mathbb R}\) \(\newcommand{\twovec}[2]{\left[\begin{array}{r}#1 \\ #2 \end{array}\right]}\) \(\newcommand{\ctwovec}[2]{\left[\begin{array}{c}#1 \\ #2 \end{array}\right]}\) \(\newcommand{\threevec}[3]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \end{array}\right]}\) \(\newcommand{\cthreevec}[3]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \end{array}\right]}\) \(\newcommand{\fourvec}[4]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \\ #4 \end{array}\right]}\) \(\newcommand{\cfourvec}[4]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \\ #4 \end{array}\right]}\) \(\newcommand{\fivevec}[5]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \\ #4 \\ #5 \\ \end{array}\right]}\) \(\newcommand{\cfivevec}[5]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \\ #4 \\ #5 \\ \end{array}\right]}\) \(\newcommand{\mattwo}[4]{\left[\begin{array}{rr}#1 \amp #2 \\ #3 \amp #4 \\ \end{array}\right]}\) \(\newcommand{\laspan}[1]{\text{Span}\{#1\}}\) \(\newcommand{\bcal}{\cal B}\) \(\newcommand{\ccal}{\cal C}\) \(\newcommand{\scal}{\cal S}\) \(\newcommand{\wcal}{\cal W}\) \(\newcommand{\ecal}{\cal E}\) \(\newcommand{\coords}[2]{\left\{#1\right\}_{#2}}\) \(\newcommand{\gray}[1]{\color{gray}{#1}}\) \(\newcommand{\lgray}[1]{\color{lightgray}{#1}}\) \(\newcommand{\rank}{\operatorname{rank}}\) \(\newcommand{\row}{\text{Row}}\) \(\newcommand{\col}{\text{Col}}\) \(\renewcommand{\row}{\text{Row}}\) \(\newcommand{\nul}{\text{Nul}}\) \(\newcommand{\var}{\text{Var}}\) \(\newcommand{\corr}{\text{corr}}\) \(\newcommand{\len}[1]{\left|#1\right|}\) \(\newcommand{\bbar}{\overline{\bvec}}\) \(\newcommand{\bhat}{\widehat{\bvec}}\) \(\newcommand{\bperp}{\bvec^\perp}\) \(\newcommand{\xhat}{\widehat{\xvec}}\) \(\newcommand{\vhat}{\widehat{\vvec}}\) \(\newcommand{\uhat}{\widehat{\uvec}}\) \(\newcommand{\what}{\widehat{\wvec}}\) \(\newcommand{\Sighat}{\widehat{\Sigma}}\) \(\newcommand{\lt}{<}\) \(\newcommand{\gt}{>}\) \(\newcommand{\amp}{&}\) \(\definecolor{fillinmathshade}{gray}{0.9}\)Absorption vs. Variable Costing
Product cost includes Direct Materials, direct labor and overhead. Period costs are selling, general and administrative costs.
Contribution Margin is Sales – Variable Costs.
Absorption Costing (or full costing):
- Typically used for financial reporting (GAAP)
- ALL manufacturing costs are included in the cost (direct materials, direct labor, fixed and variable overhead)
- Can be misleading as some costs are not affected by products
- Fixed manufacturing overhead costs are applied to units PRODUCED and not just unit sold
- Fixed manufacturing overhead per unit calculated as Fixed manufacturing costs divided by units PRODUCED.
- Cost of goods sold = units sold x absorption cost per unit (including direct materials, direct labor, fixed and variable overhead)
Variable Costing:
- ONLY includes product variable costs meaning costs that increase with volume (DM, DL & Variable OH)
- Does not include FIXED costs as volume levels do not change these costs (fixed costs treated as period costs not product costs)
- Can provide more accurate information for decision makers as costs are better tied to production levels
- Can be applied to ALL costs and not just product costs.
Comparing Absorption and Variable Cost per unit:
| Absorption | Variable | |
| Direct Materials | Include | Include |
| Direct Labor | Include | Include |
| Overhead: | ||
| Variable Overhead | Include | Include |
| Fixed Overhead | Include | DO NOT include |
| Total Product Costs | Sum | sum |
| ÷ Total Units | ÷ Total Units | ÷ Total Units |
| Product Cost per Unit | = Cost per unit | = Cost per unit |
Note: Same formula can be applied for each product cost (Cost ÷ Units produced) to get direct material cost per unit, direct labor per unit, etc.
Income Statement Formats:
- Absorption Costing – this is your standard income statement showing Sales – Cost of Goods sold = Gross Margin (or Gross Profit) – Operating Expenses = Net Income and cost of goods sold is based on the number of units SOLD x absorption cost per unit.
- Variable Costing – this is a Contribution Margin Income Statement showing Sales – VARIABLE expenses = Contribution Margin – Fixed Expenses = Net Income and variable expenses are based on number of units sold x variable cost per unit.
- Net income on the two reports can be different if units produced do not equal units sold.
Click Absorption Variable Key Takeaway for a printable copy.