For example:

PRODUCT COSTING
CHAPTER 3 VARIETY MANUFACTURING CORPORATION (2018)

INCOME Units produced 25,000

- one of the many important measures used to evaluate Units sold 18,000
the performance of both segments and the company Unit selling price 100
as a whole. That is why managers strive to make their Variable manufacturing costs P40 per unit
performances look good by making decisions that produced
would increase income. Variable selling expenses P8 per unit sold
Fixed manufacturing costs P540,000
✓ Accountants and managers make judgement when Fixed administrative expenses P200,000
measuring income and one of the most important
factors is choosing the appropriate method in  Actual production is the same with normal operating
calculating product cost or activity costs. When level for the year
managers realized that product costing would affect
their evaluation (income aspect), they started to pay INCOME STATEMENT
attention on determination of product costs.
ABSORPTION COSTING
COST ACCOUNTING Sales (18,000 x P100) P1,800,000
- used to determine product costs by adding all Less: COGS 1,108,8000
manufacturing costs as inventoriable costs and Gross profit P 691,200
charged to revenues when sold as "cost of goods sold" Administrative costs
under the so-called absorption (full) costing method. Variable (18,000 x P8) P144,000
Fixed 200,000 344,000
ABSORPTION (FULL) COSTING METHOD Net income P347,200
- costs the products with all manufacturing costs
COGS = P61.60 (540K / 25K = 21.60 + 40 VMC
regardless of whether the manufacturing cost is
Ending Inventory = P432,200 (61.60 x 7,000 units unsold)
variable or fixed. 7,000 = 25k – 18k
- Since it includes variable and fixed manufacturing costs FMC = 151,200 (7,000 x 21,60)
(included/unexpired) in costing the product, this cannot
be used to prepare a segment income reporting
under contribution margin which is one of the best VARIABLE COSTING
measures in evaluating the performance of a Sales (18,000 x P100) P1,800,000
segment. An alternative costing method was Less: VC
VC goods sold (18k x 40) P720,000
suggested, for internal purposes only, called variable
VC & admin cost 144,000 864,000
costing. Contribution Margin P 936,000
Less: FC
COST BS IS FMC 540,000
DM Initially As goods Becomes FS & Admin cost 200,000 740,000
DL applied to expense Net income P 196,000
VMOH inventory as goods
FMOH “product cost” Are sold are sold
Ending Inventory = P280,000 (40 x 7,000)
as COGS

VARIABLE (DIRECT) COSTING METHOD

Net income can be reconciled in two methods
- Recognizes that the cost of the product must
include only those production costs that vary 2018 VC NI 196,000
directly with the volume of production. + FMC ABSORPTION 151,200
Fixed manufacturing overhead (excluded/expired) is not 2018 AC NI 347,200
treated as a product cost rather it is treated as a
period cost 2018 AC NI 347,200
- FMC ABSORPTION 151,200
COST BS IS 2018 AC NI 196,000
DM Initially applied As goods Becomes
DL to inventory expense
VMOH “product cost” as goods
Are sold are sold as
COGS
FMOH Charged to revenues (period cost) Expenses
as incurred
 OBSERVATIONS Assume further that there are no variances from the
standard variable manufacturing costs, and the fixed
When production and sales are equal , the same net manufacturing overhead incurred is exactly P150,000
per year.
income will be realized regardless of the method used.
The reason is that when production and sales are equal,
Prepare the following:
there is no fixed overhead cost that has been deferred
1. Income statements for Year 1 and Year 2 under
to inventory and all manufacturing costs were released
absorption costing
from inventory as cost of goods sold
2. Income statements for Year 1 and Year 2 under
variable costing
When sales exceed production, the net income reported 3. Show a reconciliation of the difference in operating
under the absorption costing will generally be less than income for Year 1 and Year 2, and the two years as a
the net income reported under the variable costing. whole
Because when more units is sold than produced,
inventories will decrease and fixed OH costs that were SOLUTIONS:
previously deferred in inventory under absorption
costing are released, plus the current fixed OH costs STANDARD COST = VARIABLE COST + FIXED OH RATE
were charged against income for the current year.
While under variable costing, only fixed OH costs of the
P4.00 = 3 + 1
in current year have been charged against revenues.
FIXED OH RATE = BUDGETED FIXED OH
When production exceeds sales , the net income reported
EXPECTED VOLUME OF PRODUCTION
under absorption costing will generally be greater than
the net income reported under variable costing. 150,000/150,000 units = P1
Because when more units are produced than sold, part
of the fixed OH costs of the current period are deferred
in inventory to the next period under absorption costing. VARIABLE COSTING METHOD
Only that portion of the fixed OH costs of the sold units is YEAR 1 YEAR 2
charged against income for the year. While under Sales, 140,000 and 160,000 units P700 P800
variable costing, all of the fixed OH costs for the year Less: Variable Expenses:
were charged immediately against income as a period Variable mfg. COGS:
cost Beg, Inventory, at Standard 00 90
Variable costs, P3
Add: Variable COGM., at 510 420
INCOME STATEMENT PRESENTATION USING STANDARD standard
COSTING Available for sale 510 510
Less: Ending Inventory, at 90 30
Companies using standard costing could use variable standard, P3
costing method or absorption costing. The only Variable COGS 420 480
difference is that in absorption costing method, Variable S&A expenses 35 40
production volume variance appears whenever actual Total variable cost 455 520
Contribution Margin 245 280
production deviates from the expected volume of
Less: Fixed Expenses:
production, which was used in computing the pre- Fixed factory overhead 150 15
determined fixed factory OH rate. Fixed S&A expenses 65 65
Total fixed expenses 215 215
Assume the following information: Operating Income 30 65

Direct material cost P1.30 Ending Inventory: Year 1 30,000 units x 3 = 90,000
Direct labor 1.50 Year 2 10,000 units x 3 = 30,000
Variable FOH 0.20
ABSORPTION COSTING METHOD
Standard Variable Cost per unit P3.00 YEAR 1 YEAR 2
Sales, 140,000 and 160,000 units P700 P800
Fixed FOH is budgeted at P150,000 at a Less: COGS
production level of 150,000 units Beg, Inventory, at Standard 00 120
Selling price P5 / unit (V&F) cost, P4
Budgeted and actual fixed selling and P65,000 / yr Add: COGM., at standard, P4 680 560
administrative expenses Available for sale 680 680
Less: Ending Inventory, at 120 40
Variable selling expenses is 5% of peso sales
standard, P4
COGS at standard 560 640
Actual quantities in units are: Gross Profit at actual 140 160
Year 1 Year 2 Production Volume Variance 20F 10F
Beg, Inventory - 30,000 Gross Profit at actual P160 P150
Production 170,000 140,000 Less: OPEX
Sales 140,000 160,000 S&A expenses 100 105
End, Inventory 30,000 10,000 Operating Income 60 45
When using standard costs, all costs must be stated at
standard A volume variance actual production deviates
from the expected volume of production used in the fixed
overhead rate under costing. This volume will be adjusted
to the cost of goods sold at standard to get the cost of
goods sold at actual. It is to note that:

When expected production volume and actual production

volume are the same there is no production volume
variance.

When actual volume is less than expected volume, the

production volume variance is unfavorable because
usage of facilities is less than expected and fixed
overhead is under- applied.

When actual volume is more than expected volume, the

production volume variance is favorable because
usage of facilities is more than expected and fixed
overhead is over-applied.

Computation of production volume variance based on

expected volume of production of 150,000 units

Year 1 (170,000-150,000) x P1.00 = P20,000 F

Year 2 (140,000-150,000) x P1.00. = (10.000) UF
Two years combined P10.000 F

RECONCILIATION OF VARIABLE COSTING AND

ABSORPTION COSTING

Notice the differences in their operating income for

each year. This difference can be quickly explained by
multiplying the fixed factory overhead rate by the
difference in the ending inventories and the beginning
inventories for both years. Therefore, we can say that if
production equals sales in all periods, the operating
income in both methods will be the same.

PRO FORMA RECONCILIATION

YEAR
ABSORPTION TO VARIABLE 1 2
NI per Absorption Pxxx P60 P45
+ Fixed OH beg inv. xxx 0 30
- Fixed OH end inv. (30 (10)
Net Income per VC Pxxx P30 P65

VARIABLE TO ABSORPTION 1 2
NI per Variable Pxxx P30 P65
- Fixed OH beg inv. (xxx) (0) (30)
+ Fixed OH end inv. xxx 30 10
Net Income per AC Pxxx P60 P45