Absorption and Variable costing Flashcards

1
Q

what are absorption and variable costing two types of?

A

Ways that firms report profits

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2
Q

How does the choice of absorption or variable costing differ between financial and management accounting?

A

• Financial: must take full costing approach so uses absorption
• Management: Choice between either method depending on which is most appropriate
-variable for planning and decision making
-absorption better for pricing and stock valuation
• Argument over which is better &treatment of indirect items

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3
Q

What will potentially differ depending on which method you choose?

A

One or the other will produce different profits if production and revenue don’t match

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4
Q

What will be assigned to product costs and period costs for absorption costing?

A
Product:
• Direct materials
• Direct labour
• Variable mfg. OH
• Fixed mfg. OH
Note: first 3 also done by variable costing
Period:
• Selling and admin costs
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5
Q

What will be assigned to product costs and period costs for variable costing?

A
Product:
• Direct materials
• Direct labour
• Variable mfg. OH
Period
• Fixed mfg. OH i.e. keep as complete amount and right off at the end of the period
• Selling and admin costs
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6
Q

Explain the process of absorption costing

A
  • Costs split into manufacturing and non-manufacturing costs
  • Manufacturing costs split into dir. material, dir. labour and MOHs
  • these are assigned to WIP stock and then finished stock & once sold put in P&L
  • Non-manufacturing costs straight to P&L
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7
Q

Explain the process of variable costing

A
  • Costs split into manufacturing and non-manufacturing costs
  • Manufacturing costs split into dir. material, dir. labour and MOHs
  • MOHs then split into variable and fixed
  • direct material/labour & VMOH assigned to WIP stock then finished goods then SOPL
  • FMOH go straight into SOPL
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8
Q

What is the layout of the absorption P&L statement?

A
  • Very similar to SOPL in annual report
  • Revenue less cost of goods sold to get gross margin
  • Less selling and admin expenses (variable and fixed)
  • When production is greater than revenue ending stock carriers proportion of the fixed MOHs onto the next period
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9
Q

What is the calculation for the cost of good sold

A

• Beginning stock
Add COGM (units produced X per unit cost) to get goods available for sale
• minus closing stock (units left X per unit cost)
note: variable costing usually has lower per unit cost

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10
Q

What is the layout of the variable P&L statement?

A
  • statement divided into variable expenses and fixed expenses
  • Deducting variable expenses from revenue gives a contribution margin
  • Fixed expenses then deducted to give net profit
  • Net profit usually lower as all MOH costs have been deducted & not carried over to the next period
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11
Q

What accounting principles are used as the reasoning for variable costing?

A
  • Objectivity-not dividing MOH costs which is more subjective
  • Prudence- reflecting complete amount of MOH in a statement as those MOH likely to spend in that period
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12
Q

What accounting principles are used as the reasoning for absorption costing?

A
  • Accruals/matching principle-including parts of MOH in each product in order to properly match cost to benefit
  • Prudence-need to fully value stock and variable costing is undervaluing
  • Argument that splitting costs into variable and fixed is subjective too as it requires discretion from accountants
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13
Q

What is reconciliation?

A
  • Allows any
  • Shows why there is a difference between the net profit in absorption vs variable statements
  • Difference due to the stock not sold- so to reconcile MOH costs per unit should be multiplied by the stock leftover and added to the variable net profit
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14
Q

What may happen in different financial years?

A

The per-unit cost may change

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15
Q

How does the relationship between production and sales impact which P&L statement will have higher profits?

A
  • When production>sales= Absorption profit>variable profit

* When production

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16
Q

What are the advantages of variable costing?

A
  • Management finds it easy to understand
  • Consistent with CVP analysis
  • Net profit is closer to net cash flow
  • Consistent with standard costs and flexible budgeting
  • Easier to estimate profitability of products and segments
  • Profit is not affected by changes in stock, only sales
  • Impact of fixed costs on profits emphasised
17
Q

What are the arguments against variable costing?

A

•Fixed production costs are incurred in the production of output- It is fair to charge all output with a share of these costs
• Charging only variable costs makes it difficult to assess if a product is profitable or not (IF)
• Product pricing can be a challenge (IF)
-(IF) =fixed manufacturing overhead are a high proportion of total costs

18
Q

What is the impact of just-in-time (JIT) stock methods?

A

Production tends to equal sales in this method so, the difference between variable and absorption profit tends to disappear

19
Q

What are the benefits of absorption?

A

• Good for multi-products to assess profitability if not all products are sold and on a item by item basis

20
Q

What is ‘normal activity’?

A

Production average over the last 3 years