Absorption vs. variable costing: illustrative problem
Illustrative problem: absorption vs. variable costing
A company manufactures a single product. The following data is provided for the month:
| Description | Amount |
| 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 | $72,000 |
| Variable Selling & Admin (8,000 × $2) | $16,000 | $16,000 |
| Fixed Selling & Admin | $20,000 | $20,000 |
| Fixed Manufacturing OH (period cost) | – | $40,000 |
| Operating Income | $4,000 | –$4,000 |
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 |