Absorption Costing

A system of accounting for costs in which

both fixed and variable production costs
are considered product costs.
Fixed
Costs
Product
Variable
Costs
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Variable Costing
A system of cost accounting that only
assigns the variable cost of production to
products.
Fixed
Costs
Product
Variable
Costs
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The McGraw-Hill Companies, Inc.

Absorption and Variable Costing

Absorption
Costing

Product costs

Variable
Costing
Direct materials
Direct labor
Variable mfg. overhead

Product costs

Fixed mfg. overhead

Period costs
Period costs

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Selling & Admin. exp.

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Summary Comparison of Absorption

(AC) and Variable Costing (VC)
Production versus
Sales

Produced > Sold

Produced < Sold

Produced = Sold

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Total
Inventory
Effect

Period Expense Effect

Profit Effect

Increase

Fixed mfg.
costs expensed
AC

Fixed mfg.
< costs expensed
VC

AC > VC

Decrease

Fixed mfg.
costs expensed
AC

Fixed mfg.
> costs expensed
VC

AC < VC

Fixed mfg.
Fixed mfg.
costs expensed = costs expensed
AC
VC

AC = VC

No change

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Evaluation of Variable Costing

Management finds it
easy to understand.

Advantages

Impact of fixed
costs on profits
emphasized.
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Consistent with
CVP analysis.

Emphasizes contribution in
short-run pricing decisions.

Profit for period not

affected by changes
in fixed mfg. overhead.

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Evaluation of Absorption Costing

Fixed manufacturing overhead is
treated the same as the other product
costs, direct material and direct labor.

Advantages

Consistent with long-run

pricing decisions that must
cover full cost.

External reporting
and income tax law
require absorption costing.
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Impact of JIT Inventory Methods

In a JIT inventory system . . .

Production tends
to equal sales . . .

So, the difference between variable and

absorption income tends to disappear.
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The McGraw-Hill Companies, Inc.

Throughput Costing
Unit-level
spending for
direct costs.

Product
cost

Unit-level costs are incurred every time a unit of

product is manufactured and will not be incurred
again until the next unit is manufactured.

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The McGraw-Hill Companies, Inc.

Throughput Costing
Example
In an automated process direct material may be
the only unit-level cost and so is the only product cost.
All other manufacturing costs are expensed as period costs.
Incentive to
overproduce
is reduced

Average unit cost does

not vary with changes
in production levels.

Advantages
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The McGraw-Hill Companies, Inc.