Accounting-Finance

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Wednesday, November 3, 2010

Features Variable Costing System

Accounting ,
A costing method that includes only variable manufacturing costs as inventoriable costs is known as variable costing system. It excludes all fixed manufacturing costs from inventoriable costs.

 The main characteristics or features of variable costing system can be expressed as follows:

1. Cost Differentiation

Variable costing differentiates the manufacturing overheads into fixed and variable. The variable costs are treated as the product cost and fixed costs are treated as period cost.

2. No Difference In Unit Cost

Variable costing does not show differences in average unit cost of production with the fluctuation of output.

3. Decrease In Cost Of Production

Unit cost of production decreases with increase in output due to constant level of fixed cost.

4. Cost Separation

Separate of mixed cost into fixed and variable proportion.

5. Decision Making

Variable costing helps in decision making procedures providing necessary informations and data.

The fixed cost such as rent, depreciation, salary etc. are incurred even if there is no production. So, they are not considered product cost and are treated as period cost. Hence fixed costs are treated as expenses of the period. They are not transferable to next period as such they are not included in inventories.
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Advantages And Disadvantages Of Absorption Costing System

Accounting ,
Advantages Of Absorption Costing System

 Following are the main advantages of absorption costing system:

1. Absorption costing recognizes fixed costs in product cost. As it is suitable for determining price of the product. The pricing based on absorption costing ensures that all costs are covered.

2. Absorption costing will show correct profit calculation than variable costing in a situation where production is done to have sales in future ( eg. seasonal production and seasonal sales).

3. Absorption costing conforms with accrual and matching accounting concepts which requires matching costs with revenue for a particular accounting period.

4. Absorption costing has been recognized for the purpose of preparing external reports and for stock valuation purposes.

5. Absorption costing avoids the separating of costs into fixed and variable elements.

6. The allocation and apportionment of fixed factory overheads to cost centers makes manager more aware and responsible for the cost and services provided to others.

Disadvantages Of Absorption Costing System

 Major limitations or disadvantages of absorption costing can be summarized as follows:

1. Absorption costing is not useful for decision making. It consider fixed manufacturing overhead as product cost which increase the cost of output. As a result, it does not help in accepting specially offered price for the product. Various types of managerial problems relating to decision making can be solved only with the help of variable costing system.

2. Absorption costing is not helpful in control of cost and planning and control functions. It is not useful in fixing the responsibility for incurrence of costs. It is not practical to hold a manager accountable for costs over which he/she has not control.

3. Some current product costs can be remove from the income statement by producing for inventory. As such, managers who are evaluated on the basis of operating income can temporarily improve profitability by increasing production.
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Advantages And Disadvantages Of Variable Costing System

Accounting , Finance
Advantages Of Variable Costing System

The major advantages of variable costing are summarized as follows:

1. Variable costing is easy to understand and use. It is applicable to standard costing and budgetary control.

2. The valuation of closing stock on the basis of variability of cost will not facilitate the transfer of part of fixed cost to next period.

3. No need of computation of unit fixed cost, over and under absorption of fixed overhead because contribution margin over and above the fixed cost is the profit margins.

4. In variable costing system, profit is calculated on the basis of sales volume rather than production units.

5. Variable costing system assist management to take rationale decision analyzing the effects of sales and production policy.

6. Variable costing system concentrates management on controlling the controllable costs i.e Direct costs and avoids the tension of allocating the fixed cost without taking any basis.

7. Variable costing assist to management for taking rational decision regarding profit planning and cost control.

Disadvantages Or Limitations Of Variable Costing System

The major drawbacks or disadvantages of variable costing system are as follows:

1. Difficulty in segregating overhead cost into fixed and variable cost.

2. It is not justifiable to exclude fixed manufacturing overhead from inventories.

3. Wide fluctuation in profits due to seasonal demand.

4. Variable costing is not useful for long term planning and decision making.

5. Variable costing is not acceptable for external reporting purpose.
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Tuesday, November 2, 2010

Determination Of Income Under Variable Costing Approach (VCA)

Accounting , Finance
We can determine Income under variable costing approach (VCA) as follows:

*Essential Working Notes:
i. Product cost rate, PCR= Total per unit cost of:
* Direct Material
* Direct Labor
* Direct Expenses
* Variable manufacturing overheads

ii. Stock valuation = Units X PCR
iii. Closing stock of finished goods = Opening stock + Actual output - Sales unit
iv. Standard manufacturing fixed costs = SO X FMOR
where, SO = Standard output or budgeted output or normal output or planned output
FMOR = Fixed manufacturing overhead cost per unit.

Income Statement Under Variable Costing Approach(VCA)
Particulars............................................................Amount
A. Sales Revenue (SU X SR)..........................................XXX
B. Variable manufacturing cost of good sold:
i. Direct material (AO X rate)...........................................XXX
ii. Direct labor (AO X rate)...............................................XXX
iii. Direct expenses (AO X rate).......................................XXX
iv. Variable mfg. overheads (AO X rate)..........................XXX
V. opening stock of finished goods.................................XXX
Vi Less: closing stock of finished goods........................(XXX)
C. Total mfg. contribution (A-B).....................................XXX
Less: Total Non-mfg. variable costs.............................(XXX)
D. Total final contribution...............................................XXX
E. Total fixed costs:
i. Manufacturing fixed costs (standard)...........................XXX
ii. Non-manufacturing fixed costs (standard)...................XXX
F. Net income before tax (D-E).......................................XXX

Here,
SU = Sales Unit, SR = Sales Rate, AO = Actual Output, Mfg. Costs = Manufacturing costs.
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Monday, November 1, 2010

Comparison Between Variable Costing And Absorption Costing

Accounting ,
The heart of the difference between variable costing and absorption costing for financial accounting is the accounting for fixed manufacturing costs. All variable manufacturing costs are inventoriable product costs under the both methods. But fixed manufacturing costs are treated differently. Under variable costing, fixed manufacturing costs are treated as expenses of the period. Under absorption costing, fixed manufacturing costs are inventoriable costs. They are then deducted as the costs of goods sold when sales occur.

Since fixed manufacturing costs are excluded in inventoriable product costs under variable costing, it shows a lesser inventory value. In other words, the value of inventory is understated under variable costing.

Unlike that, under absorption costing, product costs are inflated by fixed manufacturing costs. Therefore, inventories are over-stated in absorption costing.

There is a direct relation between the difference in the value of inventory or asset and the net income of the period. Inventory is a current asset. As the size of an asset increases profit also increases and vice-verse.
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Concept Of Product Costs And Period Costs

Accounting ,
What Is Product Cost ?

The cost of making a product is called product cost. Product cost is also known as manufacturing cost.Product costs are taken for inventory valuation. Therefore, product costs are sometimes called the inventorial costs. Inventorial costs are all costs of a product that are regarded as assets when they are incurred and then become cost of good sold when the product is sold. If we define product costs differently, it affects the value of inventory and our profits differ. So, the understanding of product costs has a greater value from the perspective of inventory valuation and income reporting. Raw material cost is a precise example of product cost.

What Is Period Cost ?

The costs that are indifferent to the level of production are period costs. Period costs do not change with the change in production volume. Rather, these costs are incurred either for sales activity or with the passage of time. Office and administrative department costs, and marketing department costs are good examples of period costs. Period costs are not taken for inventory valuation. All period costs are deducted from the revenues of the same period.
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Concept And Meaning Of Variable Costing And Absorption Costing

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Variable Costing

variable costing is a method of inventory costing in which all variable manufacturing costs are included as inventoriable costs. In variable costing method, all fixed manufacturing costs are excluded from inventoriable costs. They are instead treated as costs of the period in which they are incurred. Variable costing is a method of recording and reporting costs that regards only those manufacturing costs, which tend to vary directly with the volume of activity, as product costs. Variable costing is also known as 'Marginal Costing' or 'Direct Costing.

Product cost under variable costing:Direct material+ Direct labor+ Variable manufacturing costs
Period cost under variable costing:
Fixed manufacturing costs+ General & administration costs+ Selling and distribution costs

Absorption Costing

Absorption costing is the method of inventory costing in which all variable manufacturing costs and all fixed manufacturing costs are included in inventoriable costs. In absorption costing method, inventory 'absorbs' all manufacturing costs.Absorption costing is also known as 'Conventional Costing' or 'Full Costing'.

Product cost under absorption costing:
Direct material+Direct labor+Variable manufacturing costs+ Fixed manufacturing costs.
Period costs under absorption costing:
General & administrative costs + Selling and distribution costs.
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