Formats of Income Statement
Conventional Income Statement
Variable Costing Income Statement
presents cost according to function — namely, (1) cost of goods sold which is composed of manufacturing costs such as materials, labor, and factory overhead and (2) operating expenses composed of selling and administrative expenses. This format does not highlight cost behavior pattern.
Conventional Income Statement
highlights cost behavior patterns and classifies costs according to behavior.
Variable Costing Income Statement
also called full or conventional costing, product cost include all the cost element of production namely direct materials, direct labor and all factory overhead costs. This method includes both variable and fixed manufacturing costs in determining product costs.
Absorption Costing
also called direct costing, is a product costing method that includes only the variable manufacturing overhead costs (direct labor, direct materials, variable overhead) in the computation of product costs.
Variable Costing
SIMILARITIES OF VARIABLE AND ABSORPTION COSTING
Both are methods of costing inventories. Both are methods of determining the cost of the products manufactured.
The basic difference between these two methods:
is on the treatment of fixed factory overhead.
Absorption Costing - according to function, to wit, manufacturing, selling and administrative costs.
Variable Costing - according to behavior - namely fixed and variable costs.
Cost Segregation
Absorption Costing - include both variable and fixed manufacturing costs which are materials, labor, variable overhead and fixed overhead.
- always higher than Variable Costing because it includes fixed overhead cost, which is not part of product cost in Variable Costing.
Variable Costing - include only the variable manufacturing overhead costs (materials, labor and variable overhead).
Cost of Inventories
Absorption Costing - fixed overhead is treated as product cost.
Variable Costing - fixed overhead is treated as period cost.
Treatment of Fixed Factory Overhead
Absorption Costing - income may be equal to, or higher, or lower than income under Variable Costing depending on production and sales.
Variable Costing - may be equal to, higher, or lower than Absorption Costing.
Amount of Income
- It refers to a cost item included in determining the cost of the product which is allocated between sold and unsold units.
- The portion of the cost allocated to the unsold units becomes part of the cost of inventory.
- Current income is diminished by that portion of the cost allocated to the units sold during the period. The portion allocated to unsold units is treate d first as an ASSET, being part of the cost of inventory, until the units are sold, when it is then charged against income for such period.
Product Cost
- It refers to a cost item charged against current revenue or treated as expense on the basis of time period without regard to production and sales.
- It is non-inventoriable cost, meaning that it is not part of the cost of inventory.
- It decreases income for the current period for its full amount.
Period Cost
ARGUMENTS FOR THE USE OF VARIABLE COSTING
- Variable Costing reports are simpler and more understandable.
- Data needed for break-even and cost-volume profit analyses are readily available.
- The problems involved in allocating fixed costs are eliminated.
- Variable Costing is more compatible with the standard cost accounting system.
- Variable costing reports provide useful information for pricing decisions and other decision making problems encountered by management.
ARGUMENTS AGAINST VARIABLE COSTING
- Problem in segregating costs into fixed and variable.
- Importance of allocating fixed costs.
- Violation of the matching principle.
- Inventory Costs and other related accounts are understated.
