Rules Regarding Absorption Costing Versus Variable Costing

Rules about unit sales and production under the two costing methods are as follows:

If sales are variable and production constant

 a. When production is equal to sales, then absorption costing and variable costing will give the same amount of net income.

b. When production is greater than sales, then Net Income under absorption costing will be greater than net income under variable costing because a portion of the fixed costs was deferred to other years under the absorption method.

c. When production is less than sales, then Net Income under absorption costing will be less than net income under variable costing because a portion of the fixed costs that were deferred from previous years will be absorbed into this year’s cost of goods sold.

d. The value of inventory will be greater under the absorption method because of the deferred costs; however the total unit count will be the same for each accounting method.

e. Over the long-term, net income will be equal under both methods.

If sales are constant and production is variable then

a. Net income under variable costing is not influenced by the fluctuations in sales (given a constant production) because none of the fixed manufacturing costs are deferred.

b. Net income under absorption costing is influenced by the fluctuations in sales (given a constant production) because a portion of the fixed manufacturing costs are deferred and may be used each year to increase costs.

 

Calculation of Product and Period Cost of

SQUARE PHARMACEUTICALS LTD.

 

Calculation of product and period cost of SQUARE PHARMACEUTICALS LTD. by using both Absorption Costing and Variable Costing Methods for the 2007 are shown in the following two tables:

 

Calculation of Product Cost under Absorption Costing and Variable Costing:

 

Particulars

Total (TK.)

Per Unit Cost (TK.)

Production in units

3,076,850,000

Absorption

Costing

Variable

Costing

Direct Material note-1

Variable Manufacturing Overhead

Fixed Manufacturing Overhead note-2

Total

3,569,146,000

215,379,500

523,064,500

4,307,590,000

 

1.16

0.07

0.17

1.40

1.16

0.07

 

1.23

 

  

Calculation of Period Cost under Absorption Costing and Variable Costing:

 

Particulars

Total (TK.)

Per Unit Cost (TK.)

Sales in units

3,076,620,000

Absorption

Costing

Variable

Costing

Fixed Manufacturing Overhead note-2

 

Variable selling and distribution expenses

 

Fixed selling and distribution expenses

Variable administrative expenses

Fixed administrative expenses

Total

523,064,000

 

399,960,600

 

615,324,000

92,298,600

307,662,000

1,938,309,200

-----

 

0.13

 

0.20

0.03

0.10

0.46

0.17

 

0.13

 

0.20

0.03

0.10

0.63

 

 

Note-1

Direct material includes the raw materials, packaging materials, and purchase of finished goods.

 

Note-2

Fixed manufacturing includes the salaries, allowances and wages, factory employee’s fees lunch, rental expenses, depreciation and others.