Full Absorption Costing

Learning Outcomes

  • Distinguish between variable costing and full absorption costing

Let’s take another look at the variable costing model for BlankBooks, Inc. for a $1,530 target profit:

BlankBooks, Inc.
CVP Analysis – target profit
For the month ending July 31, 20XX
Units $/Unit Total
Sales 2,900 $     10.00 $     29,000.00
Variable costs 2,900 $      8.30 24,070.00
Contribution Margin $      1.70 Single Line4,930.00
Fixed costs       3,400.00
Operating income Single Line$      1,530.00Double line
CM ratio 17.00%

 

Remember, we were assuming throughout this module that BlankBooks, Inc. uses a Just-in-Time inventory system, only manufacturing books as they are ordered, and that there is no finished goods inventory on hand at the beginning or end of the period. Let’s also assume that the company hit the sales goal exactly, producing and selling 2,900 books in July. Here is the income statement prepared by the financial accountants for external users using the GAAP-mandated full absorption costing method:

BlankBooks, Inc.
Income Statement
For the month ending July 31, 20XX
Financial Categories Raw Materials Costs Work-in-Progress Costs Finished Goods/Overhead Costs Financial Totals
Sales $  29,000.00
Subcategory, Cost of Goods Sold
      Beginning raw materials $600.00
      Raw materials purchased 17,270.00
      Ending raw materials (470.00)
      Raw materials transferred to WIP Single Line $  17,470.00
      Beginning WIP –
      Direct Labor 5,800.00
      Manufacturing overhead 1,200.00 (FC)
      Ending WIP –
      WIP transferred to finished goods Single Line $   24,400.00
      Beginning finished goods –
      Goods available for sale Single Line24,400.00
      Ending finished goods –
            Cost of Goods Sold $  24,400.00
Gross Profit Single Line4,600.00
Subcategory, Selling, general, and administrative costs
      Sales Salaries $    2,000.00 (FC)
      Commissions 870.00
      Internet expenses 200.00 (FC)
Total selling, general, and administrative costs Single Line 3,070.00
Operating income Single Line1,530.00
Provision for income taxes 21% 321.30
Single Line$  1,208.70Double line
Per unit cost, full absorption $     8.41Double line

 

Let’s do a quick review of variable costing before we dive into absorption costing:

You can view the transcript for “Variable Costing (the Variable Costing method in Managerial Accounting)” here (opens in new window).

When all units manufactured (2,900) are sold (2,900), operating income under absorption costing is the same as it is under variable costing, $1,530.00. Under both costing methods, $3,400.00 of fixed factory overhead costs is deducted to arrive at operating income. It just appears in two different line items.

  • On the variable costing statement, the $3,400.00 in fixed costs follows the contribution margin line.
  • Under absorption costing, the $3,400.00 is split between cost of goods sold and SGA based on whether the amount is a product cost or a period cost (look for the FC).

Under absorption costing, the per-unit cost of $8.41 is determined by dividing cost of goods available for sale (goods manufactured) by number of units sold:

$24,400.00 / 2,900 = 8.41379310… rounded to the nearest penny = 8.41

Here is a more in-depth illustration of absorption costing:

You can view the transcript for “Absorption Costing Example” here (opens in new window).

Before we go on to compare results of operations under the two systems, let’s check your understanding of the concept of absorption costing.

Practice Question