Decision Points

1. How does variable costing differ from absorption costing?

Variable costing and absorption costing differ in only one respect: how to account for fixed manufacturing costs. Under variable costing, fixed manufacturing costs are excluded from inventoriable costs and are a cost of the period in which they are incurred. Under absorption costing, fixed manufacturing costs are inventoriable and become a part of cost of goods sold in the period when sales occur.

2. How does operating income differ under variable and absorption costing?

The variable-costing income statement is based on the contribution-margin format. Under it, operating income is driven by the unit level of sales. Under absorption costing, the income statement follows the gross-margin format. Operating income is driven by the unit level of production, the unit level of sales, and the denominator level used for assigning fixed manufacturing costs.

3. Why might managers build up finished-goods inventory if the company uses absorption costing?

When absorption costing is used, managers can increase current period operating income by producing more units for inventory. Producing for inventory absorbs more fixed manufacturing costs into inventory and reduces costs expensed in the income statement in the current period. Critics of absorption costing characterize this possible manipulation of income as the major negative consequence of treating fixed manufacturing costs as inventoriable costs.

4. How does throughput costing differ from variable costing and from absorption costing?

Throughput costing treats all costs except direct materials as costs of the period in which they are incurred. Throughput costing results in a lower amount of manufacturing costs being inventoried than either variable or absorption costing.

5. What are the different capacity levels a company can use to compute the budgeted fixed manufacturing cost rate?

Capacity levels can be measured in terms of capacity supplied—theoretical capacity or practical capacity. Capacity can also be measured in terms of output demanded—normal capacity utilization or master-budget capacity utilization.

6. What are the major factors managers consider in choosing the capacity level to compute the budgeted fixed manufacturing cost rate?

The major factors managers consider in choosing the capacity level to compute the budgeted fixed manufacturing cost rate are (a) effect on product costing and capacity management, (b) effect on pricing decisions, (c) effect on performance evaluation, (d) effect on financial statements, and (e) tax requirements.

7. What issues must managers take into account when planning capacity levels and when assigning capacity costs?

Critical factors when planning capacity levels and for assigning capacity costs include the uncertainty about the expected spending on capacity costs and the demand for the installed capacity; the role of capacity-related issues in nonmanufacturing areas; and the possible use of activity-based costing techniques in allocating capacity costs.