Absorption vs Variable Costing Flashcards
What is absorption costing?
A costing method where all manufacturing costs (DM, DL, variable MOH, and fixed MOH) are included in the cost of inventory and expensed as COGS when sold.
What is variable costing?
A costing method where only variable manufacturing costs (DM, DL, and variable MOH) are included in inventory costs, and fixed MOH is treated as a period expense.
Why is absorption costing required by GAAP?
It aligns with the expense recognition principle, deferring product costs to inventory until sold and then expensing them as COGS.
What are the advantages of variable costing?
Supports decision-making by separating variable and fixed costs.
Eliminates incentives to overproduce for inventory.
Provides consistent treatment of fixed costs for predictable income statements.
How does fixed MOH affect the balance sheet under absorption costing?
Fixed MOH is deferred to inventory (as part of product costs) and only expensed when the inventory is sold.
How does variable costing treat fixed MOH?
Fixed MOH is expensed directly on the income statement in the period incurred as a period cost.
What is the fixed-MOH volume variance?
The variance reflecting differences between actual and planned production levels, impacting the cost per unit.
What are the three inventory scenarios under absorption costing?
Sell all units produced: Costs move fully from inventory to COGS.
Produce more than sold: Inventory increases, deferring some fixed MOH costs.
Sell more than produced: Inventory decreases, releasing previously deferred costs to COGS.
Why does absorption costing sometimes incentivize overproduction?
Increasing production spreads fixed MOH across more units, reducing cost per unit and boosting income by deferring costs to inventory.
How do absorption and variable costing impact operating income differently?
Under absorption costing, income can vary based on production levels, while variable costing reflects income based solely on sales volume.
When would operating income be higher under absorption costing?
When more units are produced than sold, as fixed MOH costs are deferred to inventory instead of expensed.
When would operating income be higher under variable costing?
When fewer units are produced than sold, as all fixed MOH costs have already been expensed in prior periods.
Why is fixed-MOH volume variance not applicable under variable costing?
Variable costing does not allocate fixed MOH to inventory, so no variance occurs from production levels.
How does absorption costing impact financial statements?
It defers fixed MOH to inventory on the balance sheet and recognizes it in COGS upon sale.
What type of income statement format is commonly used with variable costing?
The contribution margin income statement, separating variable and fixed costs.
