Accounting 6 profit reporting variable and absorption costing Flashcards
What is profit reporting?
Get an an sense if you are make a profit or not.
What are the types of profit reporting?
3 types:
- Income statement (profit and loss) - required by government (absorption)
- Balance sheet (statement of financial position)
- Cash flow statement
Which 2 types of income statements can you do?
Absorption costing:
- The profitability is the gross margin
Entails: reveune, COGS, Gross margin, sellilng and adm expences, EBIT, net or operating profit.
Variable costing:
- The profitability is the contribution margin
Entails: reveune, variable COGS, contribution margin, fixed expences, EBIT net or operating profit.
Profit vs absorption
Variable:
Profit is not affected in changes in production because only variable cost are included in COGS
Fixed MOH is treated as a period expense regardless of how many sold.
= Since fixed costs do not change with production volume and are already accounted for in the period, the only factor affecting profit is the number of units sold, not how many units are produced
Absorption:
- Profit is affected by changes in production because fixed overhead cost are deferred in inventory (balance sheet) and not expensed until sold.
- When fewer units are produced than sold = more of the fixed overhead costs are expensed immediately as part of the (COGS) = reducing profit.
- Fixed manufacturing overhead costs are spread across the total number of units produced, the more units a company produces, the lower the fixed overhead cost per unit.
- If the company produces more than it sells, as the costs are “stored” in the unsold inventory rather than immediately expensed
What do we use Variable in income statement for?
Internal decision making:
- view of how business decicions will affect profitability in short term
- insight into cost behavior, contribution margins, break-even points to help make decicion regarding pricing, prooduction, product mix and profitability.
Formel for gross margin?
revenue-cost of goods sold
Formel of contribution margin?
Revenue-variable cost of goods sold
What is gross margin?
Gross margin helps assess how efficiently a company is producing its goods relative to its sales.
Gross margin focuses on production efficiency.
What is contribution margin?
Contribution margin shows much revenue is contributing to covering fixed costs and generating profit.
contribution margin includes more detailed variable cost information related to specific sales and operations
Profit reporting under variable costing and absorption costing results in different figures for profit due to the way fixed manufacturing overhead costs are treated. Why?
Absorption:
Fixed manufacturing overhead is included in the cost of the inventory and is expensed only when the product is sold.
As a result, profits can be higher in periods of lower sales if there is unsold inventory because a portion of the fixed overhead costs remains capitalized as part of inventory on the balance sheet.
Variable:
Fixed manufacturing overhead not included in the cost of inventory, it is treated as period cost.
The profit is more closely tied to sales volume rather than production volume.
Variable Costing: Inventory is valued as variable costs only.
Absorption Costing: Inventory is valued at variable + fixed costs
In variable costing, profits fluctuate more based on the number of units sold.
In absorption costing, profits can be higher when production exceeds sales because fixed overhead costs are deferred as inventory
What are the 2 core classifications in an income statement beside reveune?
Product cost and period cost
What are product costs and COGS?
- Product costs are all the costs directly tied to producing goods in general.
- COGS represents the direct costs associated with the production of goods that a company has sold during a specific period
SO
Product costs become COGS when the related products are sold.
Until products are sold, product costs are part of inventory (an asset on the balance sheet).
Once the product is sold, the product costs are transferred to the income statement as COGS
They are:
Variable:
DL
DM
Variable MOH
(inventory period cost)
Absorp:
DL
DM
Variable + fixed MOH
(Fixed MOH is included in the cost of inventory and only expenced when product sold)
What are period cost?
Period costs are expenses that are not directly tied to the production process (often over a period).
These are costs that are expensed in the period in which they are incurred, regardless of production.
Why unit cost in absorption costing?
Unit computation is essential for
controlling costs,
ensuring profitability,
making informed pricing decisions,
maintaining accurate financial reporting.
Without precise unit cost calculations, a company risks inaccurate financial data, poor decision-making, and lower profitability.
Why unit cost in variable costing?
In variable costing, accurate unit computation is vital for determining the variable cost per unit, which is essential for:
Calculating contribution margins and profit.
Conducting break-even analysis.
Setting competitive and profitable prices.
Ensuring proper cost control and inventory valuation.
By focusing only on variable costs, unit computation in variable costing helps businesses make informed decisions based on sales volume, contribution margin, and overall cost management.
see picture on slide 81-83:D
