Absorption and variable costing system Flashcards
What are the principles of an Absorption costing system?
Both variable and fixed manufacturing costs are absorbed in the inventory valuation. Variable costs are allocated to products based on resources used, while a pre-determined recovery/ absorption rate is used to allocate the fixed manufacturing costs. Non-manufacturing costs are written off as a period cost in the period incurred.
What are the 4 denominator-level measures?
Explain each.
1) Theoretical maximum capacity: Measure of maximum efficiency at 100%.
2) Practical capacity: Maximum capacity less activity lost arising from unavoidable interruptions.
3) Normal activity: Capacity required to satisfy average customer demand over a long-term period.
4) Budgeted activity: Activity level based on capacity utilisation required for the next budget period.
What are the principles of a Variable costing system?
Only variable manufacturing costs are considered in the inventory value. All fixed costs are written off as a period cost in the period incurred.
What causes the difference in profits between the two costing systems?
The difference between the net profits of the different costing systems is a result of the fixed manufacturing costs included in inventory.
How does production affect profits between the costing systems?
1) Production is equal to sales
The same amount of fmoh will be brought forward. Profits will be the same for both.
2) Production exceeds sales
Under absorption costing, a greater amount of fmoh in the closing inventory is being deducted from the period’s expenses than is being brought forward in the opening inventory for the period. A general rule is that when production > sales, the absorption costing will show a higher profit.
3) Sales exceeds production
Greater amount of fmoh are brought forward in the absorption costing system as an expense in opening inventory than s being deducted in the closing inventory adjustment. Therefore the variable costing system produces higher profits.
What is the purpose of over-/under recovery of fmoh?
It does not cause a difference in the profit between the two systems. It is merely an adjustment to an estimation to ensure that the net overheads recognised equal the actual overheads incurred, which is exactly what a variable costing system recognises from the start. (Absorption costing system)
How do you calculate the overhead absorption rate/ pre-determined overhead rate?
POR= Budgeted fmoh/ budgeted activity.
Allocated fixed cost= POR* Actual activity.
Do the profit reconciliation.
Absorption costing profit
Add: fmoh o/b
Less: fmoh c/b
=Variable costing profit
