Chapter 6 Key Points

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:

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.