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absorption costing versus variable costing

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What are the differences between Absorption Costing Versus Variable Costing? Give an explanation and a complete example.

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These two costing methods apply to manufacturers who are making a product and need to compute the cost for each unit in order to record the cost in inventory.

Absorption costing, which is required by GAAP reporting, includes fixed costs in the cost per unit that is recorded in inventory. Variable costing only includes the variable costs in the cost per unit that is recorded in inventory. Variable costing, instead of spreading the fixed costs to the units produced, puts the full fixed costs of production in the income statement as a period expense.

Here is an example:
.................................................................per unit
Direct ...

Solution Summary

Your response is 260 words and explains which firms need to understand these two methods, which GAAP requires, how the methods differ and gives examples of how costs would be handled in each method. An exhibit is shown to make it easy to "see." Response is in everyday language suitable for novices.

See Also This Related BrainMass Solution

Absorption Costing Vs. Variable Costing

The Johnson Company produces a very popular product. The company had the following results for its the last two years:

Year 2014
Year 2015

2014: $600,000
2015: $600,000

Cost of goods sold
2014: $400,000
2015: $340,000

Administration Costs:
2014: $150,000
2015: $150,000

Gross margin
2014: $200,000
2015: $260,000

Net operating income (loss)
2014: $50,000
2015: $110,000

Additional information about the company is as follows:

In Year 2014, the company produced and sold 20,000 units of their product product. In 2015, the company also sold 20,000 units, but increased production to 25,000 units. The company' variable production cost is $6 per unit and its fixed manufacturing overhead cost is $300,000 per year. Fixed manufacturing overhead costs are applied to the product on the basis of each year's unit production. Variable selling and administrative expenses are $1 per units sold.

- Compute the unit product cost for each year under absorption costing and under variable costing.
- Prepare an income statement for each year, using the contribution approach with variable costing.
- Reconcile the variable costing and absorption costing income figures for each year.
- Explain why the net operating income for Year 2015 under absorption costing was higher than the net operating income for Year 2014, although the same number of units were sold in each year.

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