absorption and variable costing

Question 1

what are product costs?

Answer 1

product costs are held in inventory in the and transferred to the income statement as an expense when they are sold

Question 2

what are period costs

Answer 2

• period costs are charged immediately against sales. Unlike product costs, they are classified as expenses right away. They are not included in inventory
• period costs include selling and distribution expenses, and general and administrative expenses. These costs are presented directly as deductions against revenues in the income statement

Question 3

what are absorption and variable costing?

Answer 3

variable - these costs are incurred regardless

fuel + a portion of + variable costs

Question 4

in terms of absorption and variable costing what costs would fall under each type of costs (product/period)

Answer 4

absorption costing;
product costs
- direct materials
- direct labour
- variable manufacturing overhead
- fixed manufacturing overhead

period costs;
- selling & admin expenses

variable costing:
product costs
- direct materials
- direct labour
- variable manufacturing overhead

period costs
- fixed manufacturing overhead
- selling & admin expenses

Question 5

impact of profits

Answer 5

1st year - production > sales - stock increases by 5000 units - absorption>variable

2nd year - production<sales - stock decreases to zero - absorption<variable

both years combined - production = sales - no change - absorption=variable

Question 6

advantages of variable costing

Answer 6

• management finds it easy to understand
• easier to estimate profitability of products and segments
• provides useful information for decision making (relevant costing, CVP analysis)
• removes the effect of inventory changes from profit
• net profit is closer to net cash flow
• impact of fixed costs on profits emphasised

Question 7

what are disadvantages of variable costing (and advantages of absorption costing)?

Answer 7

• fixed production costs are incurred in the production of output. It is fair to charge all output with a share of these costs
• charging only variable costs makes it difficult to assess if a product is profitable or nor
• product pricing can be a challenge

Question 8

how to choose a costing method?

Answer 8

• absorption costing appreciates the importance of fixed costs. In the long-term, prices need to cover all costs.
• Absorption costing is consistent with external reporting
• for internal reporting purposes:
• variable costing should be used for planning and decision making
• absorption costing is better for pricing and inventory valuation