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Variable Costing | Absorption vs Variable | Problems and Solutions

Arjun EP

Published on: February 5, 2022

Variable Costing | Internal Costing | Direct Costing

Variable costing is also known as internal costing, direct costing and marginal costing.

Variable cost helps to administrator to solve the problem about production planning.

Under this method, production cost is calculated on variable basis.

Variable costing includes direct materials, direct labour and variable manufacturing cost in product cost.

It includes fixed manufacturing cost, administrative, selling and distribution cost in period cost.

Direct materials, direct labour, variable manufacturing cost:

= Production units x Cost per unit

Period costing under variable costing = Fixed manufacturing cost + Administrative cost + S&D cost

Total variable, selling and distribution cost = Sales units x Cost per unit

Sold units = Opening stock + Production – Closing stock

Variable costing | Cost allocation

Keep in Mind (KIM)

There are three types of question:

If question is given, you can be asked to calculate variable costing as well as absorption costing and reconciliation statement.

If variable costing is given in question, you are asked to calculate absorption costing and reconciliation statement.

If absorption costing is given in question, you are asked to calculate variable costing and reconciliation statement.

Income Statement under Variable Costing

Particulars				Amount $
Sales revenue (sales units @ $)				xxxx
(A)				xxxx
Variable cost:
	Direct materials	(production units @ $)		xxxx
	Direct labour	(production units @ $)		xxxx
	Variable production overhead	(production units @ $)		xxxx
		Total variable cost or Cost of production		xxxx
Add:	Beginning inventory	(opening stock @ $)		xxxx
Less:	Ending inventory	(closing stock @ $)		xxxx
		COGS (B)		xxxx
		Gross contribution (A – B)		xxxx
Less:	Variable administrative cost	(production units x $)		xxxx
Less:	Variable S&D cost	(sales units x $)		xxxx
		Net contribution		xxxx
Less:	Fixed production cost	( ± absorption, if any)	xxxx
	Fixed administrative cost	(production units x $)	xxxx
	Fixed selling and distribution cost	(sales units x $)	xxxx
Net Income				xxxx

Note: If there is under absorption in absorption costing, it is added with fixed manufacturing cost in variable costing

If there is over absorption in absorption costing, it is deducted from fixed manufacturing cost in variable costing

Advantage of Variable Costing

The main advantage of variable costing are:

It is simple to understand and easy to apply.

It is useful to managerial decision for profit planning, decision making, and control.

It does not effect to calculate predetermined fixed cost.

It does not have problem relating to over or under absorption manufacturing cost.

It is suitable for standard costing and budgeting.

Breakeven point or cost volume profit analysis is totally depended on variable costing.

Disadvantage or Limitation of Variable Costing

The main disadvantage of variable costing are:

Inventory is valuation variable cost in variable costing.

That is not accepted by tax authority department.

Variable costing insists on selling function.

Manufacturing is also important function.

Variable costing impose/force for variable cost.

But segregation of variable cost from semi variable cost is not easy.

It is suitable only for short term run.

Difference between Absorption Costing and Variable Costing

Bases	Absorption Costing	Variable Costing
Cost	Fixed manufacturing overhead is considered as product cost.	Fixed manufacturing overhead is considered as period cost.
Inventory	Inventory includes the fixed manufacturing overhead. Therefore, the value of inventory will be higher	Inventory does not include fixed manufacturing overhead because it is considered as period cost. Therefore the value of inventory will be lower.
Profit	Higher the units of ending inventory, higher the profit	Lower the unit of ending inventory, lower will be the profit.
Reporting	It is suitable for external reporting purpose.	It is suitable for internal reporting purpose
Over or under absorption	Under this costing, there may be over or under absorption of fixed manufacturing.	Under this costing, there will not be over or under absorption of fixed manufacturing.

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2A

ABC Manufactures Company produces a single product; the operating data for February 2020 is given below:

Sales units 1,000 units

Production units 1,000 units

Selling price per unit $500

Materials cost per unit:		Fixed cost:
Direct materials	$60	Factory overheads	$60,000
Direct labor	$100	Administrative cost	$80,000
Variable factory overheads	$40	Selling and distribution cost	$50,000
Variable administrative overhead	$20
Variable selling and distribution	$15

Required: Income statement under variable costing

[Answer: Net income = $60,000]

SOLUTION:

Income Statement under Variable Costing

For 1,000 units

Particulars				Amount $
Sales revenue		[1,000 @ $500]		500,000
		(A)		500,000
Variable cost:
	Direct materials	[1,000 @ $60]		60,000
	Direct labour	[1,000 @ $100]		100,000
	Variable manufacturing cost	[1,000 @ $40]		40,000
		Cost of Production [$200,000 ÷ 1,000 units = $200]		200,000
Add:	Beginning inventory	[Units @ $200]		Nil
Less:	Ending inventory	[Units @ $200]		Nil
		COGS (B)		200,000
		Gross Contribution (A – B)		300,000
Less:	Variable administrative cost	[1,000 @ $20]		(20,000)
Less:	Variable selling and distribution cost	[1,000 @ $2]		(30,000)
		Net Contribution		250,000
Less:	Fixed manufacturing cost		60,000
	Fixed administrative cost		80,000
	Fixed selling and distribution cost		50,000	190,000
Net Income				60,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2B

Following are data pertaining to month of December of operation for BR Textile Company related to school dress textile:

Units sold 5,000 miters

Selling price per unit $200

Units produced 6,000 miters

Fixed manufacturing cost $100,000

Other information:

Variable cost:	Administrative expenses:	Selling and distribution expenses:
Direct materials $40	Fixed $50,000	Fixed $30,000
Direct labor $30	Variable $100,000	Variable (per unit) $10
Factory overheads $20

Required: Income statement under variable costing

[Answer: Net income = $220,000]

SOLUTION:

Given and working note:

Sold unit	=	Opening stock + Production – Closing stock
5,000	=	Nil + 6,000 – Closing stock
Closing stock	=	1,000

Income Statement under Variable Costing

For 6,000 units

Particulars				Amount $
Sales revenue		[5,000 @ $200]		10,00,000
		(A)		10,00,000
Variable cost:
	Direct materials	[6,000 @ $40]		240,000
	Direct labour	[6,000 @ $30]		180,000
	Variable manufacturing cost	[6,000 @ $20]		120,000
		Cost of Production @ $90]		540,000
Add:	Opening stock	[0 @ $90]		Nil
Less:	Closing stock	[1,000 @ $90]		(90,000)
		COGS (B)		450,000
		Gross Contribution (A – B)		550,000
Less:	Variable administrative cost			(100,000)
Less:	Variable selling and distribution cost	[5,000 @ $10]		(50,000)
		Net Contribution		400,000
Less:	Fixed manufacturing cost		100,000
	Fixed administrative cost		50,000
	Fixed selling and distribution cost		30,000	(180,000)
Net Income				$220,000

Reconciliation of Difference in Net Cost

If there is no difference in the size of opening stock and closing stock, in such a condition net income of absorption costing and variance costing is same.

The difference between opening stock, closing stock and fixed manufacturing overhead are the main cause of difference in net income.

These differences can be solved by reconciliation.

Where:

Difference in stock units	= Difference in income ÷ Fixed cost per unit
According to variable costing, Opening stock in units	= Closing stock in units − Difference in stock units
According to absorption costing, Opening stock in units	= Closing stock in units + Difference in stock units

According to variable costing, Closing stock– Opening stock	= Difference
According to absorption costing, Opening stock – Closing stock	= Difference

Reconciliation Statement

Particulars	Amount
Net income as per variable costing	xxxx
Add: Closing stock (units @ FCPU)	xxxx
Less: Opening stock (units @ FCPU)	(xxx)
Net income as per absorption costing	xxxx

Reconciliation Statement

Particulars	Amount
Net income as per absorption costing	xxxx
Add: Opening stock (units @ FCPU)	xxxx
Less: Closing stock (units @ FCPU)	(xxx)
Net income as per variable costing	xxxx

Reconciliation Statement

Particulars	Year 1	Year 2
Net income as per variable costing	xxxx	xxxx
Net income as per absorption costing	xxxx	xxxx
Different in income	xxxx	xxxx
Opening stock in units	xxxx	xxxx
Closing stock in units	xxxx	xxxx
Different stock in units (A)	xxxx	xxxx
Fixed cost per unit (B)	x	x
Different in income (A x B)	xxxx	xxxx

Keep in Mind (KIM)

FMC = fixed manufacturing cost per unit
FCPU = fixed cost per unit	= Fixed manufacturing cost ÷ Normal output
SFOR = standard fixed overhead rate

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2C

The extracted data are taken from EP Manufacturing Company:

Net profit as per variable costing	$450,000	Fixed cost	$300,000
Opening stock	10,000 units	Normal output	40,000 units
Closing stock	7,000 units

Required: Net profit as per absorption costing

[Answer: $427,500]

SOLUTION:

Fixed cost per unit (FCPU)

= Fixed manufacturing cost ÷ Normal output

= $300,000 ÷ 40,000 units

= $7.50

Reconciliation Statement

Particulars	Amount
Net income as per variable cost	450,000
Add: Closing stock (7,000 units @ $7.50)	52,500
Less: Opening stock (10,000 units @ $7.50)	(75,000)
Net income as per Absorption Cost	427,500

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2D

An absorption costing statement showed a less profit (loss) $8,000 than variable costing with the closing stock was 2,000 units in first year. An excess profit of $16,000 with 4,000 closing stock units in second year. Fixed cost per unit $8 and variable cost per unit $12 were used for two years.

Required: Reconciliation statement for net profit under variable costing system

[Answer: $45,000; ($90,000)]

SOLUTION

Given and working note:

Difference in profit	=	Difference in stock x FCPU
–8,000	=	Difference in stock x $8
Difference in stock	=	–1,000

Closing stock

Closing stock – Opening stock	=	Difference
Closing stock – 5,000	=	– 1,000
Closing stock	=	3,000 units

Closing stock of first becomes opening stock of second year

Reconciliation Statement

Particulars				Year 2020	Year 2021
Net profit as per absorption costing				(8,000)	16,000
Add: Opening stock	3,000	2,000	@ $8	24,000	16,000
Less: Closing stock	2,000	4,000	@ $8	(16,000)	(32,000)
Net profit as per variable costing				45,000	(90,000)

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2E

While converting the variable income statement of last two years 2020 and 2021:

(a) The income statement reported loss of $16,000 in 2020 with the opening stock of 5,000 units

(b) Profit of $8,000 with the closing stock of 4,000 units in 2021.

Required: (1) Opening stock in units for 2020; (2) Net profit (loss) of absorption costing by reconciliation statement;

(3) Closing stock in units for 2021

[Answer: (1) Opening stock = 3,000 units;

(2) Year 2020 loss = ($32,000); year 2021 profit = $16,000;

(3) Closing stock in 2021 = 3,000 units]

SOLUTION

Given and working note:

Difference in profit	=	Difference in stock x FCPU
–16,000	=	Difference in stock x $8
Difference in stock	=	–2,000

Closing stock

Closing stock – Opening stock	=	Difference
Closing stock – 5,000	=	– 2,000
Closing stock	=	3,000 units

Reconciliation Statement

Particulars				Year 2020	Year 2021
Net profit as per absorption costing				(16,000)	8,000
Add: Opening stock	3,000	4,000	@ $8	24,000	32,000
Less: Closing stock	5,000	3,000	@ $8	(40,000)	(24,000)
Net profit as per variable costing				(32,000)	16,000

Keep in Mind (KIM)

More or higher profit means net profit

Less or lesser profit means net loss

Use always fixed cost per unit (never use variable cost per unit)

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Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

TU: 2060 Modified

The income statement of XYZ Company based on Absorption costing is given below:

Particulars			Amount	Amount
Sales revenue		@ $40 each		400,000
Less:	Manufacturing cost
	Direct material	@ $5 each	45,000
	Direct labour	@ $10 each	90,000
	Fixed manufacturing	@ $10 each	90,000
			2,25,000
Add:	Opening stock	2,000 units @ $25 each	50,000
			2,75,000
Less:	Closing stock	1000 units @ $25 each	25,000	(2,50,000)
		Gross profit before adjustment		1,50,000
Less:	Under absorption of fixed manufacturing cost			10,000
	Gross profit after adjustment			1,40,000
Less:	Non-manufacturing cost:
	Fixed cost		60,000
	Variable cost @ $4		40,000	1,00,000
Net Income				40,000

Required: (1) Income statement by using variable costing; (2) Reconciliation of difference in profit

[Answers: (1) $50,000; (2) $10,000] *FMC in V.C = 100,000]

SOLUTION

Given and working note:

Sold units = Opening stock + Production – Closing stock

10,000 = 2,000 + 9,000 – 1,000

In the question, there is under absorption manufacturing cost $10,000

Fixed production cost $10,000 units @ $10 per unit.

So, total fxed production cost = $10,000 + $90,000 = $100,000

Income Statement under Variable Costing

For 9,000 units

Particulars				Amount
Sales revenue		(10,000 units @ $40)		4,00,000
		(A)		4,00,000
Variable cost:
	Direct materials	(9,000 units @ $5)		45,000
	Direct labour	(9,000 units @ $10)		90,000
	Variable manufacturing cost			Nil
		Cost of production ($1,35,000 ÷ 9,000 units = $15)		1,35,000
Add:	Beginning inventory	(2,000 @ $15)		30,000
Less:	Ending inventory	(1,000 @ $15)		(15,000)
		COGS (B)		1,50,000
		Gross contribution (A – B)		2,50,000
Less:	Variable administrative cost			–
Less:	Variable non-manufacturing	(10,000 units @ $4)		40,000
		Net contribution		2,10,000
Less:	Fixed production cost	[$90,000 A.C + $10,000 under]	1,00,000
	Fixed non-manufacturing cost		60,000	(1,60,000)
Net Income				$50,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

TU: 2061/S Modified

The absorption Costing income Statement of AL Manufacturing Company has been provided as:

Production 22,000 units

Sales unit 25,000 units

Particulars			Amount
Sales revenue		@ $20 (A)	500,000
Less:	Cost of goods sold:
	Variable manufacturing cost	@ $10	220,000
	Fixed manufacturing overhead cost	@ $4	88,000
		Total cost of products @ $14	308,000
Add:	Value of beginning inventory	5000 units @ $14	70,000
Less:	Value of ending inventory	2000 units @ $14	(28,000)
		Total cost of goods sold (B)	350,000
		Gross margin before adjustment (A – B)	150,000
Add:	Manufacturing overhead over absorbed		8,000
		Gross margin after adjustment	158,000
Less:	Variable S&D cost @ $3	75,000
	Fixed S&D cost	50,000	(125,000)
Net income before tax			33,000

Required: (1) Income statement under variable costing; (2) Reconciliation statement

[Answers: (1) $45,000; (2) = $33,000;

*FMC in V.C (88,000 – 8,000) = $80,000]

SOLUTION

Sold units = Opening stock + Production – Closing stock

25,000 = 5,000 + 22,000 – 2,000

Fixed cost per unit = $4* given

Income Statement under Variable Costing

For 22,000 units

Particulars				Amount
Sales revenue		(25,000 @ $20		5,00,000
		(A)		5,00,000
Variable cost:
	Direct materials
	Direct labour
	Variable manufacturing cost	(22,000 @ $10)		2,20,000
		Cost of production ($2,20,000 ÷ 22,000 units = $10)		2,20,000
Add:	Beginning inventory	(5,000 @ $10)		50,000
Less:	Ending inventory	(2,000 @ $10)		(20,000)
		COGS (B)		2,50,000
		Gross contribution (A – B)		2,50,000
Less:	Variable administrative cost			–
Less:	Variable S&D cost	(25,000 @ $3)		75,000
		Net contribution		1,75,000
Less:	Fixed production cost	($88,000 – $8,000)	80,000
	Fixed administrative cost		Nil
	Fixed S&D cost		50,000	(130,000)
Net Income				$45,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

TU: 2063 Modified

A mill has provided the cost for the annual normal capacity output of 50,000 kg.

Direct material cost per kg	$10
Direct labour cost per kg	$8
Manufacturing overhead per kg	$10 (50% fixed)
Selling and distribution overhead per kg	$4 (25% variable)
The selling price per kg	$35
The annual fixed administrative expenses incurred	$100,000
The mill sold 50,000 kg in the last year.
The store ledger recorded 10,000 kg of beginning inventory and 15,000 kg of ending inventory in the period.

Required: Income statement based on variable costing

[Answer: $50,000]

SOLUTION

Given and working note:

Sold unit	=	Opening stock + Production – Closing stock
50,000	=	10,000 + Production – 15,000
Production	=	55,000 units

Income Statement under Variable Costing

For 55,000 units

Particulars				Amount
Sales revenue		(50,000 units @ $35)		17,50,000
		(A)		17,50,000
Variable cost:
	Direct materials	(55,000 @ $10)		5,50,000
	Direct labour	(55,000 @ $8)		4,40,000
	Variable manufacturing cost	(55,000 @ $10@50%)		2,75,000
		Cost of production ($12,65,000 ÷ 55,000 units = $23)		12,65,000
Add:	Beginning inventory	(10,000 @ $23)		2,30,000
Less:	Ending inventory	(15,000 @ $23)		(3,45,000)
		COGS (B)		11,50,000
		Gross contribution (A – B)		6,00,000
Less:	Variable administrative cost	(50,000 @ $4@25%)		(50,000)
Less:	Variable S&D cost			Nil
		Net contribution		5,50,000
Less:	Fixed production cost	(50,000@ $10@50%)	2,50,000
	Fixed administrative cost	(given)	1,00,000
	Fixed S&D cost	(50,000 @ $4@75%)	1,50,000	(5,00,000)
Net income				$50,000

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

TU: 2066 Modified

A Manufacturing Company has reported its income statement under absorption costing technique as under:

Particulars		Amount	Amount
Sales revenue	(10,000 units x $45)		450,000
Less: Cost of goods sold:
Beginning inventory	(2,000 x $27)	54,000
Variable manufacturing cost	(9,000 x $23)	207,000
Fixed manufacturing cost	(9,000 x $4)	36,000
Ending inventory	(1,000 x $27)	(27,000)	(270,000)
Gross margin before adjustment			180,000
Less: Fixed manufacturing cost under absorbed			(4,000)
Less: Variable administrative cost			(50,000)
Net income			126,000

Required: (a) Income statement under variable costing; (b) Reconciliation statement

[Answer: $130,000]

SOLUTION

Income Statement under Variable Costing

For 9,000 units

Particulars				Amount
Sales revenue		[10,000 units @ $45]		450,000
		(A)		450,000
Variable cost:
	Direct materials	[9,000 units @ $0]		Nil
	Direct labour	[9,000 units @ $0]		Nil
	Variable manufacturing cost	[9,000 units @ $23]		207,000
		Cost of production ($207,000 ÷ 9,000 = $23)		207,000
Add:	Beginning inventory	[2,000 units @ $23]		46,000
Less:	Ending inventory	[1,000 units @ $23]		(23,000)
		COGS (B)		230,000
		Gross contribution (A – B)		220,000
Less:	Variable administrative			(50,000)
	Variable S&D			Nil
		Net contribution		170,000
Less:	Fixed manufacturing cost	[$36,000 A.C. + $4,000 under absorbed]	40,000
	Fixed administrative cost		Nil
	Fixed S&D cost		Nil	(40,000)
Net income				$130,000

Reconciliation Statement

Particulars	Amount
Net income as per absorption costing	126,000
Add: Opening stock (2,000 units @ $4*)	8,000
Less: Closing stock (1,000 units @ $4*)	(4,000)
Net income as per variable costing	$130,000

#####

Problems and Answers of Variable Costing

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2A

Following are data pertaining to month of December of operation for ABC Textile related to school dress:

Opening stock 2,000 units	Administrative expenses:
Units produced 6,000 units	Fixed $250,000
Normal output 5,000 units	Variable $250,000
Units sold 7,000 units	Selling and distribution expenses:
Selling price per unit $300	Variable (per unit) $20
Fixed manufacturing cost $200,000	Fixed (per unit) $15
Variable cost:
Direct materials $50
Direct labor $40
Factory overheads $30

Required: (a) Income statement under variable costing; (b) Reconciliation statement

[Answer: (1) Net income = $315,000; (2) $275,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2B

AK Manufacturing Company has reported its income statement under absorption costing technique as under:

Particulars			Amount	Amount
Sales revenue		(10,000 units x $45)		450,000
Less:	Cost of goods sold:
	Beginning inventory	(2,000 x $27)	54,000
	Variable cost	(9,000 x $23)	207,000
	Fixed manufacturing cost	(9,000 x $4)	36,000
	Ending inventory	(1,000 x $27)	(27,000)	(270,000)
	Gross margin before adjustment			180,000
Less:	Fixed manufacturing cost under absorbed			(4,000)
	Gross margin after adjustment			176,000
Less:	Other variable cost			(50,000)
Net income before tax				$126,000

Required: Income statement under variable costing technique

[Answer: Net income under variable costing = $130,000;

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2C

Following details are given to you:

Normal capacity 200,000 units per year

Standard variable manufacturing expenses $20 per unit

Fixed manufacturing overhead $300,000 per year

Variable selling expenses $2 per unit

Fixed selling expenses $100,000

Unit sale price $25

The operating results for the year ending December of the last year were as follows

Sales 150,000 units

Production 180,000 units

Required: (a) variable costing income statement; (b) Reconciled profit under absorption costing

[Answers: Income under VC = $50,000, under AC = $95,000]

Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Br = P = Birr = Currency of your country

PROBLEM: 2D

XYZ Manufacturing Company with normal capacity of 50,000 units supplied you with the following particular:

Production	55,000 units
Sales	60,000 units
Closing stock	5,000 units
Unit variable manufacturing cost	$6
Unit fixed manufacturing overhead	$3
Unit variable selling and administrative cost	$2
Fixed selling and administrative cost	$90,000
Unit selling price	$15