Why variable costing and absorption costing create different net operation income? exactly how to reconcile net operating earnings figures created by these two costing approaches?

Variable costing and absorption costing usually create different network operating income figures. The reason is the the fixed production overhead expense is not treated the same method under 2 costing methods. To understand just how the difference in treatment of fixed manufacturing overhead cost alters the net operating income figures of 2 costing systems, we must prepare two earnings statements, one under change costing and one under absorption costing. Because that this purpose, consider the following example:

Example

A agency prepares variable costing earnings statement because that the use of interior management and also absorption costing revenue statement for the usage of outside parties favor creditors, banks, taxes authorities etc. The company manufactures a product the is sold for $80. The variable and also fixed price data is offered below:

Direct materials: $30.00Direct labor:$19.00

Factory over head:Variable cost: $6.00Fixed price ($45,000/9000 units): $5.00

Marketing, general and administrative:Variable cost (per unit sold): $4.00Fixed cost (per month): $28,000

During the month that June, 9,000 devices were produced and also 7,500 systems were sold. The opening inventory to be 2,000 units.

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Required:

Prepare two earnings statements, one utilizing variable costing technique and one utilizing absorption costing method.Explain the difference in network operating income (if any) under 2 approaches.

Solution

(1) earnings statements

(a). Absorb Costing:

*

*Computation of units in ending inventory:

*

(b). Change Costing:

*

Reconciliation that net operation income:

*

(2). Explanation the the distinction in net operating income:

Notice that the network operating earnings under absorb costing is $7,500 ($92,000 – $84,500) higher than the network operating revenue under variable costing. This difference is since of fixed manufacturing overhead the becomes the component of ending inventory under absorption costing system. The ending inventory absorbs a portion of fixed production overhead and reduces the burden of the existing period. In this way a part of fixed cost that relates come the current duration is transferred to the following period.

Under variable costing, the fixed production overhead cost is not contained in the product cost yet charged come the earnings statement that the relevant duration in the entirety. As such no part of fixed cost is soaked up by the ending inventory.

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In our example, the network operating revenue is greater under absorb costing than variable costing because closing perform is higher 보다 the opening inventory.