# Absorbtion Costing VS Variable Costing

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Chapter 7 Notes

Page 1

Variable Costing

Absorption

As we have seen in previous chapters, when you manufacture your own inventory, the cost of that inventory includes all of the costs associated with running the factory that produces the inventory.
Generally, no part of the factory cost is expensed.
Instead, it is capitalized as the cost of the inventory produced. It is only expensed when the inventory is sold. At that point the cost of the inventory becomes
Cost of Goods Sold. This system is referred to as
Absorption Costing. It is also know as “Full Costing” and
“Full-Absorption Costing”.
The thought is that the inventory absorbs all of the factory costs fully.

As we have seen, inventory costs are made up of the following under
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Assuming that Lucy sold all of the units that it produced, you would have the following
Income Statements produced by the two methods:
Absorption Costing Income Statement
Variable Costing Income Statement
(25x10K)
(25x10K)
Sales Revenue:
\$250,000
Sales Revenue: \$250,000
(15x10K) Less VC:
COGS:
-150,000
(10x10K)
VCOGS:
-100,000
VSG&Adm:
-30,000
Gross Margin:
\$100,000
Contrib.Marg:
\$120,000
(30K+30K) Less FC:
Less: SG&Adm:
-60,000
F MO/H:
-50,000
F SG&Adm:
-30,000
Oper. Profits:
\$40,000
Oper. Profits:
\$40,000
As you can see, both methods produce the same Operating Profits. (This statement assumes that either: (i) your manufacturing costs are the same in the current period and prior periods, or (ii) you are using LIFO).
On the other hand, if the number of units that you sell differs from the number of units produced in this period, then the Operating Profits reported using the two methods will differ. Please send comments and corrections to me at mconstas@csulb.edu

Chapter 7 Notes

Page 4

Assume that Lucy sold only one-half of its production. Because the number of units sold are one-half of the units that were sold previously then Lucy’s Variable Costs and
Sales