Chapter 6 Flashcards
What are the two methods that can be used to value units of product for accounting purposes
absorption costing and variable costs
Variable costing
includes only variable production costs in product costs.
How is fixed manufacturing overhead treated in variable costing?
treated as a period cost and charged off against revenue each period
Absorption costing
treats all costs of production as product costs regardless if variable or fixed and a portion of fixed manufacturing overhead is allocated to each unit of product
What happens if inventories increase under aborption costing?
a portion of fixed manufacturing overhead costs of the current period is deferred to future periods in the inventory account. When the units are later taken out of inventory and sold, the deferred fixed costs flow through to the income statement as part of COGS
Why are the ending inventory figures different when comparing aborbtion and variable costing?
under variable costing, only the variable manufacturing costs are included in inventory. Under absorption costing, both variable and fixed manufacturing costs are included in inventory
What costing system is suited for providing data for CVP computations?
variable costing method
Why is absorption costing method bad for CVP computations?
absorption costing makes no difference between fixed and variable cost
Why is variable costing method good for CVP computations?
it classifies costs by behavior
What happen when production equals sales?
inventories do not change meaning no change in fixed manufacturing overhead costs in inventory under aborption costing. therefore, under both aborption and variable costing all current fixed OH will flow to income statement as expense
What happens when production exceeds sales?
inventories grow, meaning some of fixed OH costs will be deferred in inventories under aborsption costing. Since all of the current fixed OH costs are expensed under variable costing, the net operating income under aboprtion costing will be greater than net operating income under variable costing
What happens when sales exceed production?
Inventories decrease meaning fixed OH costs that had been deferred in inventories in previous periods will be released to the income statement as part of COGS as well as all of current fixed OH. Since only current fixed OH expensed under VC, the net operating income under aborption costing less than net operating income under VC
What is the long term difference in income comparing absorption costing and variable costing
cumulative net operating income figures will be the same; fixed OH in ending inventories will be different under absorption costing. Cumulative net opearting income will be identical when ending inventories are reduced to zero
Which costing method is affected by changes in production volume?
Absorption costing net operating income because for any given lvl of sales net operating income will increase as level of output increases therefore inventories increase
What is the argument for using absorption costing?
all manufacturing costs must be assigned to units of product so as to properly match costs with revenues. Fixed OH is essential therefore must be included when costing units of product regardless how cost behaves
Argument for variable costing
fixed OH are incurred in order to have capacity produce. therefore incurred regardless of whether anything is actually produced. Since theses costs are not caused by any particular unit of product and are incurred to provide capacity for a particular period, matching principle dictate that fixed OH must be expensed in current period
What are the advantages of variable costing (aka contribution approach)
- more useful for CVP analysis 2. Income is not affected by changes in production volume 3. Avois misunderstandings concerning unit product costs 4. fixed costs are more visible 5. understandability 6. control is facilitated 7. incremental analysis is more straight forward
Is variable costing permitted in by the IRS?
nope. not generally acdepted by auditors and not permitted by IRS
what’s the solution to distortions in net operating income
finished goods inventories almost disappear and WIP kept to minim. thus fixed OH cannot be shifted between periods under absorption costing and variable and absorption will show same thing
how is fixed OH treated under absorption costing
treated as a product cost hence is an asset until products are sold
How is fixed OH treated under variable costing
treated like period cost and deducted in full from current period’s revenues
How are selling and administrated expenses treated under VC and absorption costing?
both treat as period costs
What do advocates of variable costing believe
fixed manufacturing costs are not cost of any particular unit of product therefore costs should be incurred to have capacity to make products during a particular period
What costs are treated as product costs in absorption costing?
DM, Direct labor, variable manufacturing overhead, and fixed manufacturing overhead are all treated as product costs
