Textbook

1. External financial reporting decisions

2. Planning, budgeting, and forecasting

3. Performance management

4. Cost management

4.1 Measurement concepts

4.1.1 Cost behavior, cost objects, and cost pools

4.1.2 Product and period costs, cost drivers, and cost measurement methods

4.1.3 Inventory cost flow: trading vs. manufacturing

4.1.4 Absorption vs. variable costing: impact on inventory and income

4.1.5 Absorption vs. variable costing: illustrative problem

4.1.6 Joint and by-product costing: key concepts

4.1.7 Joint and by-product costing: cost allocation methods and by-product costing

4.2 Costing systems

4.3 Overhead costs

4.4 Supply chain management

4.5 Business process improvement

5. Internal control

6. Technology and analytics

Wrapping up

4.1.5 Absorption vs. variable costing: illustrative problem

Achievable CMA Part 1

4. Cost management

4.1. Measurement concepts

Our CMA Part 1 course is currently in development and is a work-in-progress.

Absorption vs. variable costing: illustrative problem

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Illustrative problem: absorption vs. variable costing

Absorption costing carries fixed manufacturing overhead in inventory as a product cost, while variable costing expenses it immediately as a period cost.

A company manufactures a single product. The following data is provided for the month:

Description	Amount
Beginning inventory	0 units
Units produced	10,000 units
Units sold	8,000 units
Selling price per unit	$15.00
Variable manufacturing cost per unit	$6.00
Total fixed manufacturing overhead	$40,000
Variable selling & administrative cost	$2.00 per unit sold
Fixed selling & administrative expenses	$20,000

Required:

Compute unit product cost under absorption and variable costing.
Prepare an income statement under each method.
Reconcile the difference in operating income.

1. Unit product cost comparison

Cost component	Absorption costing	Variable costing
Direct materials + labor + VMOH	$6.00	$6.00
Fixed manufacturing OH/unit	$4.00 ($40,000 ÷ 10,000)	–
Total unit product cost	$10.00	$6.00

2. Operating income comparison

Income statement	Absorption costing	Variable costing
Sales (8,000 × $15)	$120,000	$120,000
COGS	(8,000 × $10) = $80,000	(8,000 × $6) = $48,000
Gross margin	$40,000	–
Variable selling & admin (8,000 × $2)	$16,000	$16,000
Contribution margin	–	$56,000
Fixed selling & admin	$20,000	$20,000
Fixed manufacturing OH (period cost)	–	$40,000
Operating income	$4,000	–$4,000

Absorption income is $8,000 higher because the 2,000 units added to inventory this month carry $4 of fixed overhead each, deferred instead of expensed.

3. Reconciliation of income difference

Reconciliation item	Amount
Difference in operating income (Absorption – Variable)	$8,000
Reason: Fixed OH deferred in ending inventory
= 2,000 units × $4 fixed OH/unit	$8,000

Key rule: The income difference equals the change in inventory units × fixed overhead per unit. Production > sales: absorption income is higher (overhead deferred in inventory). Production < sales: variable income is higher (prior overhead released). Production = sales: the two methods report equal income.

Joint and by-product costing, activity-based costing, overhead allocation, and cost of quality are each covered in their own dedicated chapters later in the course.

Absorption vs. Variable Costing Basics

Absorption costing: fixed manufacturing overhead (FMOH) included in product cost, capitalized in inventory
Variable costing: FMOH expensed immediately as period cost
Unit product cost formula differs:
- Absorption = variable mfg cost/unit + (total FMOH ÷ units produced)
- Variable = variable mfg cost/unit only

Income Statement Structures

Absorption costing: Sales – COGS = Gross margin; then subtract selling & admin expenses
Variable costing: Sales – variable costs (COGS + variable S&A) = Contribution margin; then subtract all fixed costs (including FMOH)
Same sales/variable S&A figures across both methods, but COGS and treatment of FMOH differ, causing different operating income

Reconciling the Income Difference

Difference in income = change in inventory units × fixed OH per unit
Key rule:
- Production > Sales → Absorption income higher (FMOH deferred in ending inventory)
- Production < Sales → Variable income higher (prior period FMOH released from inventory)
- Production = Sales → Both methods report equal income
Example: 2,000 unsold units × $4 FMOH/unit = $8,000 difference (absorption income exceeds variable income)

Next | 4.1.6 Joint and by-product costing: key concepts

Absorption vs. variable costing: illustrative problem

Illustrative problem: absorption vs. variable costing

Absorption costing carries fixed manufacturing overhead in inventory as a product cost, while variable costing expenses it immediately as a period cost.

A company manufactures a single product. The following data is provided for the month:

Description	Amount
Beginning inventory	0 units
Units produced	10,000 units
Units sold	8,000 units
Selling price per unit	$15.00
Variable manufacturing cost per unit	$6.00
Total fixed manufacturing overhead	$40,000
Variable selling & administrative cost	$2.00 per unit sold
Fixed selling & administrative expenses	$20,000

Required:

Compute unit product cost under absorption and variable costing.
Prepare an income statement under each method.
Reconcile the difference in operating income.

1. Unit product cost comparison

Cost component	Absorption costing	Variable costing
Direct materials + labor + VMOH	$6.00	$6.00
Fixed manufacturing OH/unit	$4.00 ($40,000 ÷ 10,000)	–
Total unit product cost	$10.00	$6.00

2. Operating income comparison

Income statement	Absorption costing	Variable costing
Sales (8,000 × $15)	$120,000	$120,000
COGS	(8,000 × $10) = $80,000	(8,000 × $6) = $48,000
Gross margin	$40,000	–
Variable selling & admin (8,000 × $2)	$16,000	$16,000
Contribution margin	–	$56,000
Fixed selling & admin	$20,000	$20,000
Fixed manufacturing OH (period cost)	–	$40,000
Operating income	$4,000	–$4,000

Absorption income is $8,000 higher because the 2,000 units added to inventory this month carry $4 of fixed overhead each, deferred instead of expensed.

3. Reconciliation of income difference

Reconciliation item	Amount
Difference in operating income (Absorption – Variable)	$8,000
Reason: Fixed OH deferred in ending inventory
= 2,000 units × $4 fixed OH/unit	$8,000

Joint and by-product costing, activity-based costing, overhead allocation, and cost of quality are each covered in their own dedicated chapters later in the course.

Achievable CMA Part 1

4. Cost management

4.1. Measurement concepts

Our CMA Part 1 course is currently in development and is a work-in-progress.

Absorption vs. variable costing: illustrative problem

3 min read

Font

Discuss

Feedback

Illustrative problem: absorption vs. variable costing

Absorption costing carries fixed manufacturing overhead in inventory as a product cost, while variable costing expenses it immediately as a period cost.

A company manufactures a single product. The following data is provided for the month:

Description	Amount
Beginning inventory	0 units
Units produced	10,000 units
Units sold	8,000 units
Selling price per unit	$15.00
Variable manufacturing cost per unit	$6.00
Total fixed manufacturing overhead	$40,000
Variable selling & administrative cost	$2.00 per unit sold
Fixed selling & administrative expenses	$20,000

Required:

Compute unit product cost under absorption and variable costing.
Prepare an income statement under each method.
Reconcile the difference in operating income.

1. Unit product cost comparison

Cost component	Absorption costing	Variable costing
Direct materials + labor + VMOH	$6.00	$6.00
Fixed manufacturing OH/unit	$4.00 ($40,000 ÷ 10,000)	–
Total unit product cost	$10.00	$6.00

2. Operating income comparison

Income statement	Absorption costing	Variable costing
Sales (8,000 × $15)	$120,000	$120,000
COGS	(8,000 × $10) = $80,000	(8,000 × $6) = $48,000
Gross margin	$40,000	–
Variable selling & admin (8,000 × $2)	$16,000	$16,000
Contribution margin	–	$56,000
Fixed selling & admin	$20,000	$20,000
Fixed manufacturing OH (period cost)	–	$40,000
Operating income	$4,000	–$4,000

Absorption income is $8,000 higher because the 2,000 units added to inventory this month carry $4 of fixed overhead each, deferred instead of expensed.

3. Reconciliation of income difference

Reconciliation item	Amount
Difference in operating income (Absorption – Variable)	$8,000
Reason: Fixed OH deferred in ending inventory
= 2,000 units × $4 fixed OH/unit	$8,000

Joint and by-product costing, activity-based costing, overhead allocation, and cost of quality are each covered in their own dedicated chapters later in the course.

Absorption vs. Variable Costing Basics

Absorption costing: fixed manufacturing overhead (FMOH) included in product cost, capitalized in inventory
Variable costing: FMOH expensed immediately as period cost
Unit product cost formula differs:
- Absorption = variable mfg cost/unit + (total FMOH ÷ units produced)
- Variable = variable mfg cost/unit only

Income Statement Structures

Absorption costing: Sales – COGS = Gross margin; then subtract selling & admin expenses
Variable costing: Sales – variable costs (COGS + variable S&A) = Contribution margin; then subtract all fixed costs (including FMOH)
Same sales/variable S&A figures across both methods, but COGS and treatment of FMOH differ, causing different operating income

Reconciling the Income Difference

Difference in income = change in inventory units × fixed OH per unit
Key rule:
- Production > Sales → Absorption income higher (FMOH deferred in ending inventory)
- Production < Sales → Variable income higher (prior period FMOH released from inventory)
- Production = Sales → Both methods report equal income
Example: 2,000 unsold units × $4 FMOH/unit = $8,000 difference (absorption income exceeds variable income)

Next | 4.1.6 Joint and by-product costing: key concepts

Absorption vs. variable costing: illustrative problem

Illustrative problem: absorption vs. variable costing

Absorption costing carries fixed manufacturing overhead in inventory as a product cost, while variable costing expenses it immediately as a period cost.

A company manufactures a single product. The following data is provided for the month:

Description	Amount
Beginning inventory	0 units
Units produced	10,000 units
Units sold	8,000 units
Selling price per unit	$15.00
Variable manufacturing cost per unit	$6.00
Total fixed manufacturing overhead	$40,000
Variable selling & administrative cost	$2.00 per unit sold
Fixed selling & administrative expenses	$20,000

Required:

Compute unit product cost under absorption and variable costing.
Prepare an income statement under each method.
Reconcile the difference in operating income.

1. Unit product cost comparison

Cost component	Absorption costing	Variable costing
Direct materials + labor + VMOH	$6.00	$6.00
Fixed manufacturing OH/unit	$4.00 ($40,000 ÷ 10,000)	–
Total unit product cost	$10.00	$6.00

2. Operating income comparison

Income statement	Absorption costing	Variable costing
Sales (8,000 × $15)	$120,000	$120,000
COGS	(8,000 × $10) = $80,000	(8,000 × $6) = $48,000
Gross margin	$40,000	–
Variable selling & admin (8,000 × $2)	$16,000	$16,000
Contribution margin	–	$56,000
Fixed selling & admin	$20,000	$20,000
Fixed manufacturing OH (period cost)	–	$40,000
Operating income	$4,000	–$4,000

Absorption income is $8,000 higher because the 2,000 units added to inventory this month carry $4 of fixed overhead each, deferred instead of expensed.

3. Reconciliation of income difference

Reconciliation item	Amount
Difference in operating income (Absorption – Variable)	$8,000
Reason: Fixed OH deferred in ending inventory
= 2,000 units × $4 fixed OH/unit	$8,000

Joint and by-product costing, activity-based costing, overhead allocation, and cost of quality are each covered in their own dedicated chapters later in the course.