VARIABLE COSTING

MANAGERIAL ACCOUNTING PAPERS

COMPILED BY :
GROUP 2

Edo Afrinaldi 0910532072

Merri Zulfita 1010533035
Rizki Amanda 1310532062
Dona Mutia 1310532075

ECONOMIC FACULTY OF ANDALAS UNIVERSITY

ACADEMIC YEAR 2014/2015
 VARIABEL COSTING

A. DEFINITIONS
Variable costing is a method of determining the cost of production which only takes into
account the variable production costs only. Also known as: direct costing. In variable costing fix
cost considered as periode cost wich are charged to the occurrence of income and not treated as
cost of production.
By Using Variable Costing Methods
1. Fixed factory overhead costs are treated as period costs and not as an element of cost of the
product, so the fixed manufacturing overhead costs charged to expense in the period
incurred.
2. In relation to products that have not been sold, the BOP remains attached to the inventory but
directly considered as an expense in the period incurred.
3. Delays the imposition of a fee is only beneficial if the delay is expected to avoid the cost of
the same period to come.

Absorption cost is a method of determining the cost of production, which charge the
entire cost of production of both fixed and variable behaves the product. Also known by the full
costing or Conventional Costing.
By Using Absorption Costing Methods
1. The cost of both the variable factory overhead and fixed charged to products on the basis of
rates specified in advance on the normal capacity or on the basis of actual overhead costs.
2. The difference of BOP would arise if the BOP charged contrast with real BOP case.
Note:
1. Imposition more BOP (overapplied factory overhead), occurs when BOP charged greater
than actually BOP happened.
2. Imposition BOP less (underapplied factory overhead), occurs when BOP charged smaller
than actually BOP happened.
3. If all products are processed in that period has not been sold, then the imposition of factory
overhead costs are more or less they will be used to reduce or increase the cost of goods that
are still in stock (both products in process and finished product)
4. This method will delay the imposition of fixed manufacturing overhead costs as expenses till
the time the product in question is sold.

B. DIFFERENCE BETWEEN VARIABLE COSTING AND ABSORPTION COSTING

Variable costing assigns only variable manufacturing costs to the product.
Direct materials
 Direct labor
Variable overhead

Absorption costing assigns all manufacturing costs to the product, this adds fixed
overhead to the formula
Direct materials
Direct labor
Variable overhead
Fixed overhead

FIXED OVERHEAD TREATMENT IN VARIABLE COSTING

Fixed FOH is not part of product cost, but treated as period cost, why? Because fixed cost
is associated with providing the capacity, no correlation to production activity. Whether or not
produce the product, the fixed cost still occur.
Fixed FOH cost is treated as product cost in full costing because financial accounting
defines the product cost is that all costs directly or indirectly related to produce the product.
Hiring the production manager, and having factory building is indirectly aimed to produce the
product. So, all costs related to these resources (production managers salaries, depreciation
expense, maintenance expense, and property tax of factory building) should be a part of product
cost.

C. ADVANTAGE AND DISADVANTAGES OF VARIABLE COSTING

Companies need absorption costing to prepare statements to satisfy external parties and
variable costing for better management. Both the costing methods have benefits and limitations.
Following are the main advantages and disadvantages of variable costing system:

1. Advantages of Variable Costing

a. Variable costing provides a better understanding of the effect of fixed costs on the net
profits because total fixed cost for the period is shown on the income statement.

b. Various methods of controlling costs such as standard costing system and flexible
budgets have close relation with the variable costing system. Understanding variable costing
system makes the use of those methods easy.

c. Companies using variable costing system prepare income statement in contribution

margin format that provides necessary information for cost volume profit (CVP) analysis.
 This data cannot be directly obtained from a traditional income statement prepared under
absorption costing system.

d. The net operating income figure produced by variable costing is usually close to the flow
of cash. It is useful for businesses with a problem of cash flows.

e. Under absorption costing system, income of different periods changes with the change of
inventory levels. Sometime income and sales move in opposite directions. But it does not
happen under variable costing.

2. Disadvantages of Variable Costing

a. Financial statements prepared under variable costing method do not conform to generally
accepted accounting principles (GAAP). The auditors may refuse to accept them.

b. Tax laws of various countries require the use of absorption costing.

c. Variable costing does not assign fixed cost to units of products. So the production costs
cannot be truly matched with revenues.

d. Absorption costing is usually the base for evaluating top executives efficiency.

Limitation of Variable Costing

1. Can not be used for external reporting because not follow the GAAP / IFRS
2. It is not easy to classify cost into fixed and variable

D. FORMAT OF INCOME STATEMENT

1. Using Variable Costing
Sales xxx
Less : Variabel expenses (xxx)
Contribution margin xxx
Less : Fixed expenses (xxx)
Net income from operasion xxx

2. Using Absorption Costing

Sales xxx
Less: Cost of goods sold (xxx)
Gross profit xxx
Less: Operating expenses (xxx)
Net income from operation xxx

Notes:
The income statements present expenses by cost relationship with the principal function
in a manufacturing factory, the production function, the function of marketing and general and
administrative functions.

E. EXAMPLE PROBLEM AND DISCUSSION

Units in beginning inventory 0
Units produced 10,000
Units sold ($300 each) 8,000
Normal volume 10,000

Variable cost per unit:

Direct materials 50
Direct labor 100
Variable overhead 50
Variable selling and administrative 10

Fixed costs:
Fixed overhead 250,000
Fixed selling and administrative 100,000

Required:
1. Determine cost per unit using variable and absorption costing
2. Prepare income statement using variable and absorption costing
3. Analyze the cause of net income difference

Answer :
1. Unit cost :
 Variable costing Absorption costing
Direct materials $ 50 $ 50
Direct labor 100 100
Variable overhead 50 50
Fixed overhead + 25 + (250.000 : 10.000)
Total 200 225

Fixed Overhead unit produced

2. Income statement using variable costing :

Sales (8.000 x $ 300) $2,400,000

Less variable expenses :

Variable cost of goods sold

(8.000 x $ 200) $1,600,000

Variable selling and admin

(8.000 x $ 10) 80,000

(1,680,000)

Contribution margin (8.000 x 90*) $ 720,000

Less fixed expenses :

Income statement using absorption costing : $ 250,000

Fixed overhead
Sales $2,400,000
Fixed selling and admin. 100,000
Less: Cost of goods sold (8.000 x $225) (1,800,000)
Gross margin (350,000) $ 600,000
Less: Selling and administrative exp.
Net income $ 370,000
Variable: (8.000 x 10) 80,000
*300 Fixed:
- 210 100,000
(180,000)
Net income $ 420,000
3. The cause of net income different
Net Income variable costing $ 370.000
Net Income full/absorption costing 420.000
Difference in Net Income $ 50.000

This difference is caused by treatment difference in fixed FOH Cost

Full costing: fixed FOH in ending FG inventory (10.000 8.000 =2.000 unit x $ 25 = $
50,000) is carried over to next period. Fixed FOH as period cost is $ 200.000 ($250,000 - $
50,000), or 8.000 units sold x $ 25 = $ 200.000 (fixed FOH in COGS)
Variable costing: all fixed FOH as period cost ($ 250,000)

PRODUCTION, SALES, AND INCOME RELATIONSHIPS

If then
Production > Sales Absorption NI > Variable NI
Production < Sales Absorption NI < Variable NI
Production = Sales Absorption NI = Variable NI

In example above :
Production 10.000 sales 8.000
Absorption NI 420.000 variable NI 370.000

Absorption costing income Variable costing income = Fixed overhead x (Units produced
Units sold)

If income performance is expected to reflect managerial performance, then managers have the
right to expect--
1. As sales revenue increases from one period to the next, all other things being equal,
income should increase.
2. As sales revenue decreases from one period to the next, all other things being equal,
income should decrease.
3. As sales revenue remains unchanged from one period to the next, all other things being
equal, income should remain unchanged.

BENEFITS INFORMATION BY VARIABLE COSTING METHOD

Financial statements prepared based Variable Costing method helpful for management to:
1. Short-Term Profit Planning
In the short term, fixed costs do not change with the change in the volume of activity, so
that only the variable costs that need to be considered by management.
Income statement variable costing presents two important measures: Contribution margin, and
operating leverage.
example:
Sales Results: Rp. 1000
Variable Cost: Rp. 600
Profit Contributions: Rp. 400
Fixed Cost: Rp. 300
Net Income: Rp. 100
Contributions Earnings Ratio : contribution margin = 400 = 0,4 = 40%
sales results 1000

Operating Laverage: contribution margin = 400 = 4

net income 100
For example:
In the budget plan was decided to raise prices 12%. So the impact of this increase on short-term
profit can be determined : 12% x 40% = 4.8%
Income statement separates the fixed and variable costs, also allowing management to analyzes
the relationship of cost, volume and profit.

2. Control of cost
Fixed costs in variable costing can be grouped into two categories namely: discretionary
fixed costs and committed fixed costs.
Discretionary fixed costs are the costs that fix behave as policy management. In the short-term
costs can be controlled by management. While committed fixed cost is the cost arising from the
ownership of the plant, ekuipment and principal organisation. In the short term these costs can
not be controlled by management.

3. Decision Making
Management by using the variable costing method can determine the decision making
eg in the case of special orders.
BIBLIOGRAPHY

Hilton, Ronald W. David E. Platt.2011.Managerial Accounting Ninth Edition.New York:

McGraw-Hill/Irwin
http://www.accountingformanagement.org/advantages-and-disadvantages-of-variable-costing/
accessed at Wednesday, September, 3rd 2014 at 20.30 pm
http://www.investopedia.com/terms/v/variablecost.asp accessed at Wednesday, September, 3 rd
2014 at 20.00 pm
maaw.info/chapter2.htm accessed at Tuesday, September, 2nd 2014 at 19.45 pm