5.) Absorption and Variable Costing

Question 1

Explain how Absorption and Variable Costing applies to the costs related to driving a car on a 200 mile trip.

Answer 1

Variable:

• Only cost of driving the car 200 miles are £12 for petrol
• The only cost that varies with activity

Absorption:

• Consideration of fixed costs by unitising them (includes FCs as well as VCs)
• E.g. Car payments of £300 a month work out as £10 a day, Insurance payments of £60 a month work out as £2 a day

> > > However, fixed costs do not change, regardless if the trip is taken or not - consideration of FCs, without the need to unitise them. (POV of Variable costing)

Question 2

What Product and Period costs does Absorption Costing consider?

Answer 2

Product:

• Direct materials
• Direct labour
• Variable manufacturing overhead
• Fixed manufacturing overhead (unitising FC; not done in Variable)

Period:
- Selling & Admin expenses

Question 3

What Product and Period costs does Variable Costing consider?

Answer 3

Product (ONLY variable costs):

• Direct materials
• Direct labour
• Variable manufacturing overhead

Period:

• Fixed manufacturing overhead (FC not unitised; expensed on income statement like Selling & Admin instead)
• Selling & Admin expenses

Question 4

How do Unit Product Costs differ WRT Absorption and Variable Costing respectively?

Answer 4

Absorption:

• Fixed Man OH is unitised to give a per unit absorption rate (dividing FC cost by volume)
• As well as Direct materials, Direct labour and Variable Man OH which is split per unit

Variable:

• Just has Direct materials, Direct labour and Variable Man OH as UPC
• Fixed Man OH is treated as period expense (like Selling & Admin in both cases) and deducted from revenue

Question 5

What is Absorption Costing also known as?

Answer 5

• External Financial Reporting Statement
• Full Costing System
• Marginal Costing (factoring cost of additional units)
• Direct costing

> > > Job Costing System is based on Absorption Costing