10 Questions
What is the main difference between Absorption Costing and Variable Costing?
Treatment of Fixed Manufacturing Overheads
What is the formula to calculate Total Product Cost under Absorption Costing Method?
Direct Costs + Fixed MOH + Variable MOH
What is the purpose of calculating the Predetermined Overhead Rate?
To allocate Fixed MOH to products
What is included in the calculation of Total Cost under Variable Costing Method?
Direct Costs + Variable MOH
What is the difference between Period Costs and Product Costs?
Period Costs are related to a specific period, while Product Costs are related to a specific product
What is the formula to calculate Unit Product Cost under Absorption Costing Method?
Total Product Cost / No. of units produced
What is the purpose of calculating the Cost of Goods Sold?
To determine Gross Profit
What is the relationship between Gross Profit and Cost of Goods Sold?
Gross Profit = Revenue - Cost of Goods Sold
What is included in the calculation of Total Manufacturing Overheads?
Oven Depreciation, Rental, and Utilities
What is the purpose of calculating the Predetermined Overhead Rate for Fixed MOH?
To allocate Fixed MOH to products
Study Notes
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.
Compare the impact of Absorption Costing and Variable Costing on a company's gross profit and net profit, including product costs and period costs.
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