Comparing Variable and Absorption Costing

The easiest way to understand the difference between variable costing and absorption costing is with an example. In this chapter, we will study Stassen Company, an optical consumer-products manufacturer, and focus on its product line of high-end telescopes for aspiring astronomers.

Stassen uses standard costing:

• Direct costs are traced to products using standard prices and standard inputs allowed for actual outputs produced.
• Indirect (overhead) manufacturing costs are allocated using standard indirect rates times standard inputs allowed for actual outputs produced.

Stassen’s management wants to prepare an income statement for 2020 (the fiscal year just ended) to evaluate the performance of the telescope product line. The operating information for the year is as follows:

Actual price and cost data for 2020 are as follows:

For simplicity and to focus on the main ideas, we assume the following about Stassen:

• Stassen incurs manufacturing and marketing costs only. The cost driver for all variable manufacturing costs is units produced; the cost driver for variable marketing costs is units sold. There are no batch-level costs and no product-sustaining costs.
• There are no price variances, efficiency variances, or spending variances. Therefore, the budgeted (standard) price and cost data for 2020 are the same as the actual price and cost data.
• Work-in-process inventory is zero.
• Stassen budgeted sales of 6,000 units for 2020, which is the same as the actual sales for 2020.
• Stassen budgeted production of 8,000 units for 2020. This was used to calculate the budgeted fixed manufacturing cost per unit of $135 ($1,080,000/8,000 units).^*
• The actual production for 2020 is 8,000 units. As a result, there is no production-volume variance for manufacturing costs in 2020. A later example, based on data for 2021, does include production-volume variances. However, even in that case, the income statement contains no variances other than the production-volume variance.
• Variances are written off to cost of goods sold in the period (year) in which they occur.

Based on the preceding information, Stassen’s inventoriable costs per unit produced in 2020 under the two inventory costing methods are as follows:

To summarize, the main difference between variable costing and absorption costing is the accounting for fixed manufacturing costs:

• Under variable costing, fixed manufacturing costs are not inventoried; they are treated as a period expense.
• Under absorption costing, fixed manufacturing costs are inventoried. In our example, the standard fixed manufacturing cost is $135 per unit $(\$\text{1,080,000}÷\text{8,000}\hspace{0.17em}\text{units})$ produced.