Absorption Costing vs Variable Costing

Period Cost vs Product Cost

• Under both Variable Costing and Absorption Costing, all costs (product and period) would have been deducted to arrive at the net profit.
• No difference in the company's net profit whether Absorption Costing or Variable Costing is used.

Variable Costing

• Only variable manufacturing costs (DM, DL, VMOH) are included as product costs.
• When sales occur, inventory is transferred to Cost of Goods Sold (COGS).
• Gross profit is reduced by a lower product cost, resulting in a higher gross profit.
• Fixed Manufacturing and Non-manufacturing costs are classified as period costs.

Absorption Costing

• All manufacturing costs (DM, DL, VMOH, and FMOH) are included as product costs.
• When sales occur, inventory is transferred to Cost of Goods Sold (COGS).
• Gross profit is reduced by a higher product cost, resulting in a lower gross profit.
• Non-manufacturing costs (selling, general, and administrative) are classified as period costs.

Comparison of Product Costs

• Under Variable Costing, each unit of Tiramisu and Cheesecake's cost is lower compared to Absorption Costing.
• This is because only variable manufacturing costs are included as product costs under Variable Costing, whereas all manufacturing costs are considered product costs under Absorption Costing.

Product Cost Calculation

• Absorption Costing Method: Total Product Cost = Direct Costs + Fixed MOH + Variable MOH
• Variable Costing Method: Total Product Cost = Direct Costs + Variable MOH
• Unit Product Cost = Total Product Cost / No. of units produced

International Financial Reporting Standards (IFRS)

• IFRS requires the use of Absorption Costing (also known as "full costing") for external reporting (i.e. Financial Statements).
• The rationale for Absorption Costing is that it causes a product to be measured and reported at its complete cost.