Variable Costing vs Absorption Costing

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In variable costing, how are fixed manufacturing costs treated in the income statement?

Treated as period expenses

What is the key difference between variable costing and absorption costing?

Treatment of fixed manufacturing costs

Why does segment reporting benefit stakeholders?

Provides insights into the performance of different business units

What does absorption costing allocate to the cost of goods sold?

Both variable and fixed manufacturing costs

How does variable costing support decision-making for managers?

Provides insights into contribution margin by separating fixed and variable costs

What factors are considered when determining reportable segments under segment reporting standards?

Revenue thresholds, profitability, and strategic significance

How are intersegment revenues and expenses handled in segment reporting?

They are eliminated from the segment data

What does the contribution margin represent in segment reporting?

The amount of revenue that covers variable costs

How does segment reporting comply with external reporting standards like GAAP or IFRS?

By providing guidelines for disclosing segment information

What are some potential limitations of segment reporting?

It relies on subjective decisions in identifying segments

Study Notes

Criteria for Determining Reportable Segments

  • Reportable segments are determined based on factors such as revenue thresholds, profitability, and strategic significance.
  • Segments that meet certain quantitative thresholds or exhibit distinct operating characteristics are typically identified as reportable segments.

Intersegment Revenues and Expenses

  • Intersegment revenues and expenses are eliminated from the segment data to avoid double counting and to reflect only external transactions.
  • This ensures that the segment results accurately represent the performance of each segment to external stakeholders.

Contribution Margin

  • The contribution margin represents the amount of revenue that exceeds variable costs and is available to cover fixed costs and contribute to profit.
  • It is a key metric in segment reporting as it helps assess the profitability and viability of each segment independently.

Compliance with External Reporting Standards

  • Segment reporting standards, such as ASC 280 (GAAP) or IFRS 8, provide guidelines for disclosing information about a company's operating segments, products, services, geographic areas, and major customers.
  • Compliance with these standards ensures transparency and consistency in external reporting.

Limitations of Segment Reporting

  • Segment reporting relies on management's judgment in identifying and aggregating segments, which may lead to subjective decisions and inconsistency across companies.
  • Segment data may not fully capture the complexities of intersegment transactions or reflect changes in segment performance over time.

Evaluating a Company's Performance and Prospects

  • Investors and analysts can use segment reporting information to assess the relative contribution of each segment to the overall business, identify growth opportunities, evaluate segment profitability and risk, and make informed investment decisions based on a deeper understanding of the company's operations.

Variable Costing vs. Absorption Costing

  • Variable costing only includes variable manufacturing costs (like direct materials, direct labor, and variable overhead) in the cost of goods sold.
  • Fixed manufacturing costs are treated as period expenses in variable costing, whereas they are allocated to the cost of goods sold in absorption costing.

Treatment of Fixed Manufacturing Costs

  • In variable costing, fixed manufacturing costs are treated as period expenses and are not included in the cost of goods sold.
  • Instead, they are expensed in the period incurred.

Preference for Variable Costing

  • Variable costing provides clearer insights into the contribution margin of individual products or segments by separating fixed and variable costs.
  • This can help managers make better decisions regarding pricing, product mix, and resource allocation.

Segment Reporting and Company Performance

  • Segment reporting breaks down a company's financial results into segments or business units, providing stakeholders with insights into the performance of each segment.
  • This allows for better assessment of profitability, risk, and growth potential of different parts of the business.

Learn about the differences between variable costing and absorption costing, including how fixed manufacturing costs are treated in each method. Understand how variable costing only includes variable manufacturing costs in the cost of goods sold, while absorption costing allocates both variable and fixed manufacturing costs.

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