{"id":397,"date":"2015-10-02T13:27:01","date_gmt":"2015-10-02T13:27:01","guid":{"rendered":"https:\/\/courses.candelalearning.com\/managacct2x10xmaster\/?post_type=chapter&p=397"},"modified":"2015-12-27T15:30:15","modified_gmt":"2015-12-27T15:30:15","slug":"absorption-costing","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/suny-managacct\/chapter\/absorption-costing\/","title":{"raw":"6.1 Absorption Costing","rendered":"6.1 Absorption Costing"},"content":{"raw":"Absorption costing<\/strong>, also called full costing, is what you are used to under Generally Accepted Accounting Principles.\u00a0 Under absorption costing, companies treat all manufacturing costs, including both fixed and variable manufacturing costs, as product costs. Remember, total variable costs change proportionately with changes in total activity, while fixed costs do not change as activity levels change. These variable manufacturing costs are usually made up of direct materials, variable manufacturing overhead, and direct labor. \u00a0 The product costs (or cost of goods sold) would include direct materials, direct labor and overhead.\u00a0 The period costs would include selling, general and administrative costs.\r\n\r\nhttps:\/\/youtu.be\/5RcNPp1_stU\r\n\r\nThe following diagram explains the cost flow for product and period costs.\r\n\r\n\"absorp\"<\/a>\r\n\r\nThe product cost, under absorption costing, would be calculated as:\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
Direct Materials<\/td>\r\n<\/tr>\r\n
+ Direct Labor<\/td>\r\n<\/tr>\r\n
+ Variable Overhead<\/td>\r\n<\/tr>\r\n
+ Fixed Overhead<\/td>\r\n<\/tr>\r\n
= Total Product Cost<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nYou can calculate a cost per unit by taking the total product costs \/ total units PRODUCED.\u00a0 Yes, you will calculate a fixed overhead cost per unit as well even though we know fixed costs do not change in total but they do change per unit.\u00a0 We will assign a cost per unit for accounting reasons.\u00a0 When we prepare the income statement, we will use the multi-step income statement format.\r\n\r\nhttps:\/\/youtu.be\/YBWrDtBuRkA\r\n\r\nWe will not get as complicated in our multi-step income statement as the video example but it should have provided a refresher from what you should have learning in financial accounting.\u00a0 For our purpose, the absorption income statement will contain:\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
Sales<\/td>\r\n<\/tr>\r\n
- Cost of Goods Sold<\/td>\r\n<\/tr>\r\n
= Gross Profit<\/td>\r\n<\/tr>\r\n
Operating Expenses:<\/td>\r\n<\/tr>\r\n
\u00a0 \u00a0 Selling Expenses<\/td>\r\n<\/tr>\r\n
\u00a0 \u00a0 + General and Admin. Expenses<\/td>\r\n<\/tr>\r\n
\u00a0\u00a0 \u00a0 \u00a0 = Total Expenses<\/td>\r\n<\/tr>\r\n
= Net Operating Income<\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nGross Profit is also referred to as gross margin.\u00a0 Net operating income is Gross Profit - Total Operating Expenses and is also called Income before taxes.\u00a0 Let's look at an example:\r\n\r\nBradley Company had the following information for May:\r\n
    \r\n\t
  • Direct materials $13,000<\/li>\r\n\t
  • Direct labor $15,000<\/li>\r\n\t
  • Variable overhead $5,000<\/li>\r\n\t
  • Fixed overhead $6,000<\/li>\r\n\t
  • Fixed selling expenses $15,000<\/li>\r\n\t
  • Variable selling expenses $0.20 per unit<\/li>\r\n\t
  • Administrative expenses $12,000<\/li>\r\n\t
  • 10,000 units produced<\/li>\r\n\t
  • 9,000 units sold (1,000 remain in ending finished goods inventory)<\/li>\r\n\t
  • Sales price $8 per unit<\/li>\r\n<\/ul>\r\nFirst, we need to calculate the absorption product cost per unit:\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
    Direct Materials<\/td>\r\n$ 13,000<\/td>\r\n<\/tr>\r\n
    + Direct Labor<\/td>\r\n$ 15,000<\/td>\r\n<\/tr>\r\n
    + Variable Overhead<\/td>\r\n$\u00a0 5,000<\/td>\r\n<\/tr>\r\n
    + Fixed Overhead<\/td>\r\n$\u00a0 6,000<\/span><\/td>\r\n<\/tr>\r\n
    = Total Product Cost<\/td>\r\n$39,000<\/td>\r\n<\/tr>\r\n
    \u00f7 Total Units Produced<\/td>\r\n\u00f7 10,000<\/span><\/td>\r\n<\/tr>\r\n
    = Product cost per unit<\/strong><\/td>\r\n$ 3.90<\/strong><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nNext, we can use the product cost per unit to create the absorption income statement.\u00a0 We will use the UNITS SOLD on the income statement (and not units produced) to determine sales, cost of goods sold and any other variable period costs.\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n\r\n
    Bradley Company<\/strong><\/td>\r\n<\/tr>\r\n
    Income Statement (absorption)<\/strong><\/td>\r\n<\/tr>\r\n
    For Month Ended May<\/strong><\/td>\r\n<\/tr>\r\n
    Sales (9,000 x $8 per unit)<\/td>\r\n$ 72,000<\/td>\r\n<\/td>\r\n<\/tr>\r\n
    - Cost of Goods Sold (9,000 x $3.90 per unit)<\/td>\r\n\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a0 \u00a0 35,100<\/span><\/td>\r\n<\/td>\r\n<\/tr>\r\n
    = Gross Profit<\/td>\r\n<\/td>\r\n\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 36,900<\/td>\r\n<\/tr>\r\n
    Operating Expenses:<\/td>\r\n<\/td>\r\n<\/td>\r\n<\/tr>\r\n
    \u00a0 \u00a0 Selling Expenses (15,000 fixed + variable 0.20 x 9,000 units sold)<\/td>\r\n\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a0 \u00a0 16,800<\/td>\r\n<\/td>\r\n<\/tr>\r\n
    \u00a0 \u00a0 + General and Admin. Expenses<\/td>\r\n\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a0 \u00a0 12,000<\/span><\/td>\r\n<\/td>\r\n<\/tr>\r\n
    \u00a0\u00a0 \u00a0 \u00a0 = Total Expenses<\/td>\r\n<\/td>\r\n\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 28,800<\/span><\/td>\r\n<\/tr>\r\n
    = Net Operating Income<\/strong><\/td>\r\n\u00a0\u00a0\u00a0<\/strong><\/td>\r\n$8,100<\/strong><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\nRemember the following under absorption costing:\r\n
      \r\n\t
    • Typically used for financial reporting (GAAP)<\/li>\r\n\t
    • ALL manufacturing costs are included in the cost (direct materials, direct labor, fixed and variable overhead)<\/li>\r\n\t
    • Can be misleading as some costs are not affected by products<\/li>\r\n\t
    • Fixed manufacturing overhead costs are applied to units PRODUCED and not just unit sold<\/li>\r\n\t
    • Income statement shows Sales \u2013 Cost of Goods sold = Gross Margin (or Gross Profit) \u2013 Operating Expenses = Net Income and is based on the number of units SOLD.<\/li>\r\n<\/ul>\r\n ","rendered":"

      Absorption costing<\/strong>, also called full costing, is what you are used to under Generally Accepted Accounting Principles.\u00a0 Under absorption costing, companies treat all manufacturing costs, including both fixed and variable manufacturing costs, as product costs. Remember, total variable costs change proportionately with changes in total activity, while fixed costs do not change as activity levels change. These variable manufacturing costs are usually made up of direct materials, variable manufacturing overhead, and direct labor. \u00a0 The product costs (or cost of goods sold) would include direct materials, direct labor and overhead.\u00a0 The period costs would include selling, general and administrative costs.<\/p>\n