Chapter 7 Variable Costing A Tool for Management

Chapter 7 Variable Costing A Tool for Management - Chapter...

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Chapter 7 – Variable Costing: A Tool for Management Two general approaches are used for valuing inventories and cost of goods sold. One approach, called absorption costing, is generally used for external reporting purposes. The other approach, called variable costing, is preferred by some managers for internal decision making and must be used when an income statement is prepared in the contribution format. This chapter shows how these two methods differ from each other. Overview of Absorption and Variable Costing Absorption costing (also called the full cost method) treats all costs of production as product costs, regardless of whether they are variable or fixed. Since no distinction is made between variable and fixed costs, absorption costing is not well suited for CVP computations. Under absorption costing, the cost of a unit of product consists of direct materials, direct labor, and both variable and fixed overhead. Variable and fixed selling and administrative expenses are treated as period costs and are deducted from revenue as incurred. Variable costing (also called direct costing or marginal costing) treats only those costs of production that vary with output as product costs. This approach dovetails with the contribution approach income statement and supports CVP analysis because of its emphasis on separating variable and fixed costs. The cost of a unit of product consists of direct materials, direct labor, and variable overhead. Fixed manufacturing overhead, and both variable and fixed selling and administrative expenses are treated as period costs and deducted from revenue as incurred. Under absorption costing, all production costs, variable and fixed, are included when determining unit product cost. Under variable costing, only the variable production costs are included in product costs. Income Comparison of Absorption and Variable Costing We need some additional information to allow us to prepare income statements for Harvey Company: o 20,000 units were sold during the year. o
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This note was uploaded on 10/25/2010 for the course MGT 11B taught by Professor Hancock during the Spring '07 term at UC Davis.

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Chapter 7 Variable Costing A Tool for Management - Chapter...

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