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ktcpanet
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Joined: 17 Aug 2008
Location: United States
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Posts: 37

Posted: 21 Nov 2011 at 22:16 \| IP Logged

Okay, what I read in Wiley directly contradicts what I read on a website. I went on google trying to understand the concept better, which instead confused me more. Edit - forget the website, it agrees with Wiley- I was reading it backwards.

Wiley (question 20 mod 48) says...

A single-product company prepares income statements using both absorption and variable costing methods. Manufacturing OH cost applied per unit produced in 2009 was the same as 2008. The 2009 variable costing statement reported a profit whereas the 2009 absorption costing statement reported a loss. The difference in reported income could be explained by units produced in 2009 being ...

A. Less than units sold in 2009

A is correct because this difference in reported income is explained if units produced in 2009 are less than units sold in 2009. This is true because under variable costing, the amount of overhead included in COGS is the amt applied in 2009 (since all units produced were sold), whereas under absorption costing the OH released to COGS includes the 2008 year-end inventory.

Okay I thought about this and am editing my post. I think what I'm missing here is... The Key is whichever period had more Sales, is going to have more Costs with absorption costing, as fixed costs are matched to sales with absorption. So, that is why less sales = less income with absorption.

With variable costing, units produced = units sold, and fixed costs don't even come into the equation, so fixed costs will probably be constant over 2 years.

Okay sorry to post this, I had to think this out, I hope that maybe it helps someone. Or if my thinking is wrong let me know. (It would not be surprising, CPA exam fried my brain)

This is the website which explained more about the difference between absorption and variable costing http://www-biz.aum.edu/jheier/ABSORB2000.htm.

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divyagovil1
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Joined: 30 Jan 2009
Location: India
Online Status: Offline
Posts: 1456

Posted: 22 Nov 2011 at 05:26 \| IP Logged

Hello ktcpanet,

Not sure how to explain in the most simple manner, but
let me give it a try:

Assume numbers for year 2008:

Closing stock 1000 units
Variable cost p.u. $8
Fixed Cost $5000

Value of closing stock:

Variable costing = 1000 * 8 =$8,000

Absorption costing = 1000 * 8 = 8,000 + some portion of
FC remaining, say 2000 = $10,000

Thus, closing stock for 2008 is over-valued under
absorption costing.

Fixed costs are fully charged to Income statement
under variable costing

Now, let's come to year 2009:

Question says "The 2009 variable costing statement
reported a profit whereas the 2009 absorption costing
statement reported a loss".

Assume, in year 2009 :

Units produced 5000
Variable cost p.u. $8 (same as from 2008)[Given,
Manufacturing OH cost applied per unit produced in 2009
was the same as 2008]

Units sold 6000
Selling price $15 p.u.
Sales 6000 units * $15 p.u. = $90,000

Cost of Goods sold:

Variable costing = closing stock from 2008 $8000 +
variable mfg cost of units produced in year 2009 $8 *
5000 units = $48,000

Absorption costing = closing stock from 2008 $10000 +
variable mfg cost of units produced in year 2009 $8 *
5000 units = $50,000

Profit in 2009:

Variable costing = Sales - COGS = 90,000 - 48,000 =
$42,000

Absorption costing = 90,000 - 50,000 = $40,000

Thus, profit under absorption costing is less than profit
in variable costing. This can only hold true if :

1.) VC p.u remains same in 2008 and 2009
2.) Units produced < units sold in 2009

Since total FC have been fully charged to IS under
variable costing in year 2008, only VC would impact COGS
in 2009.

However, under absorption costing, some portion of FC
remain in closing stock for 2008, which get carried
forward to 2009 and thus, increase COGS for 2009 as VC
remains same.

numbers which i have assumed do not result in loss
for 2009, however, these explain the concept of lesser
profit under absorption costing as compared to variable
costing in year 2009.

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