University:
Grand Rapids Community College
Course:
Financial and Managerial Accounting: Information for Decisions - John J. Wild
Academic year:

2024
Views:

218

Pages:

2
Author:

stud_ice13

This passage explains how to convert income from variable costing to absorption costing, emphasizing key concepts and differences between the two methods. Here's a summary and breakdown: Conversion of Income: 1. Why Convert? o Businesses often use variable costing for internal decision-making, but they must use absorption costing for external reporting and tax purposes. 2. Conversion Formula: o To convert variable costing income to absorption costing income, use this formula: Absorption Costing Income=Variable Costing Income+(Fixed Overhe ad in Ending FG Inventory)−(Fixed Overhead in Beginning FG Invent ory) Essentially, absorption costing includes fixed overhead in the product cost, which can affect income when inventory levels change. Example (IceAge in Exhibit 19A.2): • • Year 2 Calculation: Add the fixed overhead in ending FG inventory to variable costing income. Year 3 Calculation: Subtract the fixed overhead in beginning FG inventory (incurred in Year 2) from the variable costing income of Year 3. Factors Affecting Differences in Income: • Differences between absorption costing income and variable costing income are more pronounced when: o Fixed overhead is a significant portion of manufacturing costs. o Inventory levels are high (e.g., when inventory accumulates rather than rapidly turning over). o Inventory turnover is low, leaving more costs in ending inventory. o Period of analysis is short; over long periods, differences diminish. Summary Cheat Sheet: • • • Absorption Costing: Includes fixed overhead as part of product costs. Variable Costing: Treats fixed overhead as a period expense. General Rule: If inventory levels change, then absorption costing income ≠ variable costing income. Decision-Making Insights: • Setting Target Price: Consider costs covered by variable expenses. • Special Orders: Accept if the price offered exceeds variable costs, as seen in the given example with $22 per unit. Key Terms: • • • Absorption Costing (or Full Costing): All manufacturing costs (fixed and variable) are included in product costs. Variable Costing (or Direct Costing): Only variable manufacturing costs are included in product costs. Contribution Margin: Sales minus variable costs, used to assess profitability. Quiz Insights: 1. Product Cost per Unit under Absorption Costing: $14 includes direct materials ($3), direct labor ($5), variable overhead ($3), and a portion of fixed overhead ($3). 2. Product Cost per Unit under Variable Costing: $11, which consists of direct materials ($3), direct labor ($5), and variable overhead ($3). 3. Variable Costing Product Costs: All variable costs related to production, including direct materials, direct labor, and variable overhead. 4. Difference Between Costing Methods: Fixed overhead is the primary distinction between absorption and variable costing. 5. When Production Exceeds Sales: Absorption costing produces higher income because some fixed costs are allocated to ending inventory, rather than being expensed as in variable costing. This detailed overview should help in understanding how income differences arise and the implications for internal and external reporting.