Accounting 202 Modules 3



Module 3

Case Assignment

Variable and Fixed Costs

Differences between the Absorption and Contribution Income Statements

Absorption costing is a costing method in which entire manufacturing cost observed by the units that has been produced. In short, this method comprises of both the variable cost as well as fixed incurred for the production of the goods along with the direct labor and direct material.

Contribution Income Statements is a costing method in which variable expenses are deducted from the sales in order to arrive at contribution margin. The fixed expenses are subtracted from the contribution margin for obtaining net income/loss (Warren, Reeve, Duchac, 2011).

From the above definition, it is clear that there is a huge difference between the Absorption and Contribution costing. The following are the main difference between these two methods:

In absorption costing, inventory per unit cost is inclusive of direct labor, direct material, and fixed manufacturing overhead along with the variable manufacturing overhead. As far as Contribution costing is concern, inventory per unit cost is only includes direct labor, direct material and variable manufacturing overhead. The difference is absorption costing includes fixed as well as variable while contribution only consider variable costs.

Other differences is that absorption costing compute gross margin through subtracting cost of goods sold from the sales. Contribution costing gross margin computed through subtracting cost of variable expenses from the sales in order to obtain contribution margin and then fixed expenses are deducted from contribution margin for getting net income.

Absorption costing the inventories measured at full costs while in contribution margin approach, inventories measured at variable costs.

Net Income differences

Net income under Absorption costing and Contribution approach will always be same only if the production sales are equal. If the production has been more than the sales, here net income under absorption costing will be higher than then contribution margin approach. The reason for this is the closing inventory stock will be valued at garter per unit cost comparison to the contribution margin approach since the fixed manufacturing cost will be included in the cost per unit (Horngren, 2011).

Need of creating another Income Statement in a Different Format

Companies need different income statement in difference format due to the valuable information obtained through different methods.

For instance, Absorption Costing Income Statement is legally needed by the companies to be prepared since they have to state these figures in the annual report, whereas, variable costing income statement is formulated for decision making purposes, since through this approach cost and benefit analysis can easily be computed. Managers while making decisions needs comprehensive information regarding the product costs and through this comprehensive information make effective and beneficial future decision. This other income statement indicate much detail and comprehensive information focusing on different aspect of product cost which are much advantageous for company (Horngren, 2011) .

Break-Even Analysis Can Be a Useful Tool

Breakeven analysis is a tool which identifies a point where total expenses which are incurred equals to the total sales that are made in a year ...