Management advisory Services Prof. Ma. Teresa B.

De Jesus
Topic : Direct Costing/ Absorption Costing
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Variable Costing Defined:
Variable (Direct, Differential, or Marginal) costing refers to the method of costing products whereby
the product costs consist only variable manufacturing costs: direct materials (DM), direct labor (DL) and
variable factory overhead (VFOH) with fixed factory overhead (FFOH) treated as period cost.
Absorption Costing Defined:
Absorption (Full, Conventional, Traditional) costing refers to the method of costing products whereby
the product costs consist of all manufacturing costs, fixed and variable (direct materials, direct labor, variable
factory overhead and fixed factory overhead).

SUMMARY OF THE DIFFERENCES BETWEEN THE TWO METHODS:

DIRECT COSTING ABSORPTION COSTING
1. Segregation of Costs
All costs and expenses are There is no need to segregate costs into
segregated into fixed and variable fixed and variable

2. Product Cost /Inventory Values

The inventoriable costs are: The inventoriable costs are:
Direct materials P xxx Direct materials P xxx
Direct labor xxx Direct labor xxx
Variable Factory Overhead xxx Variable Factory Overhead xxx
Fixed Factory Overhead xxx
3. Period costs
Fixed Factory Overhead xxx
Fixed Operating Expenses xxx Fixed Operating Expenses xxx
Variable Operating expenses xxx Variable Operating expenses xxx

4. Income Statement Presentation

Sales P xxx Sales P xxx
Less: Var. Mfg Costs Less: Cost of Good Sold
DM P xxx DM P xxx
DL xxx DL xxx
VFOH xxx xxx VFOH xxx
Contribution Margin, Mfg xxx Fixed factory Overhead xxx xxx
Less: Var. Oper. Exp. xxx Gross profit xxx
Contribution Margin, Final xxx Less: Operating Expenses
Less: Fixed Costs Fixed Oper. Exp. xxx
Fixed Factory Overhead xxx Variable Oper. Exp. xxx xxx
Fixed Oper. Expenses xxx xxx Net Income xxx
Net Income xxx ===
===
5. Operating Income: Relationship between
Production(P) and Sales(S) Net Income Inventory
a. P = S AC = DC BI = EI
b. P > S AC > DC BI < EI
c. P < S AC < DC BI > EI

6. Reconciliation of Net Income Figures:

Operating Income under absorption costing xxx
Add: Fixed Factory Overhead in Beg. Inventory xxx
Less: Fixed Factory Overhead in End Inventory (x x x)
Operating Income under Direct costing xxx
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Problem 1 : At the capacity of 10,000 units, the following costs are given for GSM Corporation :
Total Amount Per unit
Direct materials ……………………………… P 250,000 P 25
Direct labor …………………………………… 150,000 15
Variable factory overhead …………………….. 120,000 12
Fixed manufacturing overhead ……………….. 90,000 9
Variable operating expenses ………………….. 60,000 6
Fixed operating expenses ……………………... 50,000 5

During 2020, GSM Corporation produced 9,000 units and sold 8,000 units of its product at
P 100 per unit . Beginning inventory is 1,000 units at P 63.25 per unit.

Required : Compute the following for GSM Corporation for the year ended December 31, 2020:
1. Product unit cost Direct Costing Absorption Costing
2019 2020 2019 2020
Direct Materials P 25 P 25 P 25 P 25
Direct Labor 15 15 15 15
Variable Factory Overhead 12 12 12 12
Fixed Factory Overhead - - (90,000/8,000) 11.25 (90,000/9,000) 10
Unit Cost P 52 P52 P 63.25 P 62
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2. Cost of Ending Inventory:
Number of Units 1,000 2,000 1,000 2,000
X Unit Cost ___52 52 63.25 62
Cost of Ending Inventory P52,000 P104,000 P 63,250 P 124,000
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3. Prepare the Income Statement under both methods

4. Total Fixed costs charged during the year under

a. Direct Costing was P 140,000 ( 90,000 + 50,000)

b. Absorption costing was P 131,250

TOTAL FIXED COSTS
Fixed factory overhead
Beginning Inventory (1,000X 11.25) P 11,250
Current production 90,000
Less Ending Inventory (2,000 x 10) (20,000) P
81,250
Fixed Operating expenses
50,000
TOTAL FIXED COSTS P
131,250

5. Total Variable costs charged during the year under :

a. Direct Costing was P 464,000

b. Absorption costing was P 464,000

6. Total Period costs charged during the year under :

a. Direct Costing b. Absorption costing

Fixed Factory Overhead P 90,000 -

Variable Operating expenses 48,000 P 48,000
Fixed Operating Expenses __ 50,000 50,000
P 188,000 98,000
 ============= =========

ABSORPTION COSTING

GSM Corporation
Income Statement
For the year Ended Dec 31,2020

Sales (8,000XP100) P 800,000

Less: Cost of Goods Sold
Beginning Inventory (1,000 P
X63.25) 63,250
Add: Current Production
Variable manufacturing (9,000 XP 52) P 468,000
Costs
Fixed manufacturing (9,000 X 10) 90,000 558,000
Costs
Total 621,250
Less: Ending Inventory (2,000 X 62) 124,000 497,250
Gross Profit 302,750
Less: Operating Expenses
Variable Operating Expenses (8,000 X 6) P 48,000
Fixed Operating expenses 50,000 98,000
Net profit P 204,750

RECONCILATION OF NET INCOME FIGURES

Operating Income under absorption costing P 204,750

Add: Fixed Factory Overhead in Beg. Inventory (1,000X 11.25) 11,250
Less: Fixed Factory Overhead in End Inventory (2,000 x 10) (20,000)

Operating Income under Direct costing P196,000

 DIRECT COSTING

GSM Corporation
Income Statement
For the year Ended Dec 31,2020

Sales (8,000XP10 P 800,000

0)
Less: Variable Cost of Goods sold
Beginning Inventory (1,000 X52) P 52,000
Add: Current Production
Variable manufacturing (9,000 XP P 468,000
Costs 52)
Total 520,000
Less : Ending Inventory (2,000 X 52) 104,000 416,000
Contribution Margin, 384,000
Manufacturing
Less : Variable Operating (8,000 X 6) P 48,000
Expenses
Contribution Margin, Final 336,000
Less Fixed Costs
Fixed manufacturing P 90,000
Costs
Fixed Operating expenses 50,000 140,000
Net Profit P 196,000

SP P 100
VC (52 + 6) 58
CM 42
X UNITS SOLD 8,000
TOTAL CM 336,000
FC 140,000
NP under DC 196,000
Add FFOH End (2,000 x 10) 20,000
Less : FFOH Beg. Inv (1,000X 11.25) (11,250)
NP under absorption costing P 204,750

Fill in the blanks.

1. Direct costing is sometimes called _____________ or ____________ or _____________ costing.
2. Absorption costing is sometimes referred to as ______________ or _______________.
3. The difference between direct and absorption costing is the way _______________ are handled.
4. Product costs, representing the cost of goods manufactured under absorption costing consist of all
__________________ manufacturing costs.
5. Under direct costing, fixed overhead costs are charged to expense as _______________ costs;
while under absorption costing treats fixed costs as part of _____________________.
6. If production exceeds sales _________ costing will show a greater profit than ________ costing.
7. When there is an inventory decrease, e.g. sales in units exceed the units produced ___________
costing will show a greater profit than _______________ costing.
8. Both methods of costing will show the same results, when production and sales ____________ each
other.
9. If production fluctuated and sales are constant, ______________ profit fluctuates and _________
profit is constant.
10. If __________ is constant and ___________ fluctuates, both vary in the direction of sales.