ORIE 3150 class 22 (Nov 17th) - ORIE 3150 Variable and...

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ORIE 3150 Variable and Throughput Costing Absorption vs. Variable Up to now, we have only used absorption costing when preparing income statements and informal cost budgets. There is another method known as variable costing. What distinguishes absorption costing versus variable costing? What is the difference? In short, the only difference is the treatment of fixed manufacturing overhead. It is expensed with variable costing, and included in the asset cost with absorption costing. Variable costing treats only those costs of production which vary with output as product costs. Those would usually be direct material (usually assumed to be 100% variable), direct labor (also usually assumed to be 100% variable), and variable manufacturing overhead. Fixed manufacturing overhead is not treated as a product cost with this method. Rather it is treated as a period cost and charged off as an expense each period. We recall how absorption costing is done; it treats ALL costs of production as product costs, regardless of whether they are fixed or variable in nature. Under absorption costing, we allocate a portion of the fixed manufacturing overhead to the cost of each unit of product. Comparison of Absorption and Variable Costing 1. Deferral of fixed manufacturing costs under absorption costing. If inventories increase, then a portion of the fixed manufacturing overhead is deferred to future periods. Only later, when the units are taken out of inventory and sold, do they show up on the income statement. 2. Differences in inventory values. The ending inventory figure under the two methods will be different. Absorption costing includes the fixed manufacturing overhead allocation, variable costing does not. 3. Suitability for CVP analysis and breakeven The variable costing method is all set up for CVP analysis, as the variable and fixed costs are neatly separated. Not so with the absorption costing method! Income Statement Effects
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This note was uploaded on 03/02/2011 for the course ORIE 3150 at Cornell University (Engineering School).

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ORIE 3150 class 22 (Nov 17th) - ORIE 3150 Variable and...

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