Unit 1 Chapter 7 Flashcards
absorption costing
treats all costs of production as product costs, regardless
of whether they are variable or fixed.
Only selling and administrative expenses are period costs
Variable costing
Only costs that vary with output are treated as product costs.
Fixed manufacturing overheads and selling and administrative expenses are treated as period costs.
Movement of inventory under absorption costing
Opening inventory + Units produced - Units sold = Closing inventory
fixed manufacturing overhead cost deferred in inventory
The portion of the fixed manufacturing overhead cost of a period that goes into inventory under the absorption costing method as a result of production exceeding sales
Fixed Manufacturing overhead cost released in inventory
The portion that was deferred in the previous period is now released in the next period as it forms part of cost of goods sold
Production = Sales
No change in inventories
Absorption = Variable
Production greater than Sales
Inventories increase
Absorption greater than Variable
Production less than Sales
Inventories decrease
Absorption less than Variable
Advantages of absorption costing
recognizes that both fixed and variable overheads are necessary for production to occur.
Disadvantages of absorption costing
Does not always help management in making short-term decisions.
recognising fixed costs may make managers using these figures, think about them in a wrong way
Advantages of variable costing
Most useful for production decisions as it clearly illustrates contribution.
Operating profit is closer to net cash flow
Profit is not affected by change in
production
Management finds it easy to understand
Consistent with CVP analysis
Disadvantages of variable costing
A possibility that a positive contribution gives the illusion of profitability
IAS 2 requires absorption of fixed overheads when valuing inventory in the financial accounts.
Benefit of using JIT
The difference in the net operating income under variable and absorption costing can largely be reduced
Encourages companies to eliminate all types of inventory (materials, work-in-process and finished goods) which reduces the difference in the net operating income figure
