Variable & Absorption Costing

8/6/2019 Variable & Absorption Costing

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R.S.Rengasamy, Dept. of Textile Technology

variable & Absorption costing

Variable & Absorptioncosting


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Variable & Absorption costing

Variable & Absorption costing- Not job , Batch , Process costing systemVariable Costing : (VC)Used for = Internal reporting for decision making

w.r.ta) Price fixing on special ordersb) Optional sales mixc) Adding new product lined) Dropping new product linee) Developing production plans if certain input are in short

supplyf) Buy or make decisiong) Selling in a limited marketh) Sales mix with constraintsi) Sales mix with no constraints


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Absorption Costing : (AC)

(Full costing , Traditional costing , Conventionalcosting)

Used for = Income statement for externalreporting / IT purposesVC & AC are not mutually exclusivecomplementary in nature

Variable Costing :-Recognises only variable costs as production andselling costs


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Fixed manufacturing Over Head are excludedfrom product cost , not inventoriable , period costsand matches against the revenue for the period.

Absorption Costing:-Absorbs all cost necessary to product and have itin a saleable form.

Manufacturing Over Head are inventoriable ,

product costs matches against the revenue for theyear in which sales are made


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Per year

Normal production (Kg) 4000

Actual Production (Kg) 4800

Over Head at normal production Rs 16000

Other expenses Rs 1000

SFR (Standard Fix Over Headrate)

Rs 4/ Unit

Variable cost Rs 6/ Unit

Sales volume Nil


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Income statement (Absorption Costing)Particulars Amount (Rs)

A) Sales RevenueLess : Total cost of manufacturing

Variable costs (64800) = 28800Fix Over Head (44800) = 19200

Total = 48000

00

B) Cost of goods manufacturedPlus : Operational Inventory = 0000Less : Cost of closing Inventory

(480010) =

48000

C) Cost of goods manufacturing & sold = Nil

D) Gross margin (A-C) (Unadjusted) Nil

E) Capacity variance (Favourable)(over absd) *8004

( Fixed costs inventoriable)

3200


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Income statement (Absorption cost) continued ..

F) Gross margin (adjusted) (D+E) 3200

G) Less other expenses 1000

H) Net income before taxes 2200

* Matched against revenue of the year in which sales are made


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Income statement (Variable costing)

Particulars Amount (Rs)

A) Sales revenue Nil

B) Variable production cost 48006 = 28800

+ opening inventory (variable cost) = Nil- closing inventory (variable cost) 48006 = 28800

C) Cost of goods manufactured & sold = Nil

D) Contribution (A-C) (Manufacturing) Nil

E) Less : Fixed costsFixed Over Head = *16000

Others = 1000Total = 17000* Non-inventoriable* At normal level

F) Net income before taxes 17000

* Matched against the revenue of that year


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Data

P = S P>S P


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Income statement ( Year 1)P= S

Particulars Absorption cost Variable cost

Sales (1000012) 120000 120000

Less cost of goods

manufactured

Variable cost (100006) 60000 60000

Fixed cost (100004) 40000

Cost of goodsmanufactured & sold

100000 60000

Gross margin 20000

Contribution 60000

Less : Fixed cost 40000

Net income before taxes 20000 20000


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Income statement (Year 2) , P>SParticulars Absorption cost Variable cost

A) Sales (500012) 60000 60000

Less : cost of goods manufactured

(a) Variable cost (100006) 60000 60000

(b) Fixed cost ( 100004) 40000B) Cost of goods manufactured (a+b) 100000 60000

(i) Less : Cost of C.I

500010 50000

500006 30000

C) Cost of goods manufactured & sold 50000 (a+b-i) 30000D) G.M (A-C) 10000

Contribution 30000

Less Fixed cost 40000

Net income 10000 10000


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Income statement (Year 3) ,P


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Information for year 1 and 2Year 1 Year 2

Production (units) 170000 140000

Sales (units) 140000 160000

Standard variable production cost = Rs 6/UnitSale Price = Rs 10/UnitFixed production Over Head

at normal capacity 150000 unit = 300000 Rs

So, SFR = Rs 2.00Selling & Administrative expenses:-

Fixed Rs 130000 Variable 5% of sales


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Absorption costingParticulars Year 1 Year 2

Sales revenue 1400000 1600000

Cost of manufacturing 1360000 (81.7 Lakh) 1120000(81.4 Lakh)

+ cost of O.I 240000(80.3 Lakh)

- Cost of C.I 240000(30000

8) 80000(8

0.1 Lakh)Cost of goods manufactured&sold

1120000 1280000

G.M (Unadjusted) 280000 320000

Capacity variance 40000(200002) 20000(100002)

G.M (Adjusted) 320000 300000

Less Non production costs 200000(5% of 14 Lakh+1.3 Lakh)

210000(5% of 16 Lakh+1.3 Lakh)

Net income before taxes 120000 90000

Less income tax (35%) 42000 31500

Net income after tax 78000 58500


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Variable costingParticulars Year 1 Year 2

Sales revenue 1400000 1600000

Cost of manufacturing 1020000 840000

+ cost of O.I 180000

- Cost of C.I 180000 60000

Cost of goods manufactured & sold 840000 960000

Contribution (manufacturing) 560000 640000

Less V. non production cost 70000 80000

Contribution (final) 490000 560000

Less Fixed costFixed Over HeadFixed selling etc.

300000130000

300000130000

Net income before tax 60000 130000

I-Tax 21000 45500

Net income after tax 39000 84500


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Reconcilation statementParticulars Year 1 Year 2 Combined

Net income before tax

Absorption cost 120000 90000 210000

Variable cost 60000 130000 190000

Difference 60000 40000 20000

Changes in inventory

O.I 30000

C.I 30000 10000 10000

(A) 30000 20000 10000

Increase / Decrease in net income

(SFRA),(SFR = Rs 2) 60000 40000 20000


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Reconcilation statement(VC)Particulars Amount (Rs)

Increased in sales revenue in year 2 (20000Rs 10) 200000

LessIncreased manufactured V.C (20000Rs 6) 120000

Increased contribution 80000

LessIncreased selling & Administrative expense (5% of

sales)

10000

Increased contribution (final) 70000


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Decision making using variable costing

Special order & special price

You are operating at lower than normal capacitySome one gives extra order which boost your sales capacity

But his offer in selling price is below normal price and contributionfrom this new offer is positive.

Will you accept the order?

Your normal capacity is 15000 units

Your current capacity is 12000 units (beyond which you dont havelocal market)

Your variable cost per unit is Rs.20 and selling price (Local) is Rs.30Fixed Overhead at normal capacity = Rs 45000

Your SFOR is Rs 4500/15000 = Rs 3Extra order is 3000 units at SP/unit = Rs 22


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Using Variable costing

Additional sales revenue is (300022) =

66000Less variable cost (300020) =

60000 Additional contribution is = 600

Without this special order

SR (1200030) =

360000VC (1200020) =

240000Contribution = 120000

Using Absorption costingSales revenue (300022) =


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Make or buy a componentAnnual requirement of a component = 20000If the component is manufactured in-house(Company has spare capacity and no additionalinvestment is required the cost structure per unitisDirect material = Rs 50Direct labour = Rs 20 Variable OH = Rs 12

Fixed FOH allocated = Rs 5Total = Rs 87If you are outsource it the cost structure isPrice = Rs 80Ordering = Rs 3


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Particular Make Buy

Direct material (5020000) 1000000

Direct labour (2020000) 400000

Variable OH (1220000) 240000

Purchase price (8020000) 1600000

Ordering/inspection cost(320000) 60000

Total cost 1640000 1660000


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Optimal sales mix (No demand constraints)Particulars Product

X Y Z

Selling price / unit 108 81 72

Less variable cost / unit 60 45 40Contribution margin /unit 48 36 32

Time to produce /unit , hrs.(including stoppage time)

24 12 8

CM/hour 2 3 4

If there is no manufacturing constraints (materials, labour, machine, technical competency, layout)

What the firm do ?


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Demand constraintsOperating capacity of company is 300 days/Year

X Y Z

Demand /annum 300 1200 1500

Total hours available = 300243 (3 lines) = 21600

All three lines can produce any of X, Y, Z

For Z of 1500 unit requires 15008 = 12000 hrs.

Remaining hrs. available (21600-12000) = 9600

Units of Y that can be produced = 9600/12=800

One line exclusively allotted to Z 7200 hrs. = 900 units

2nd line 2/3rd of time (4800 hrs.) allotted to Z = 600 units

2nd line 1/3rd of time (2400 hrs.) allotted to Y = 200 units

3rd line fully allotted to Y 7200 hrs.(30024 hrs.) = 600 units

Variable & Absorption Costing

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