Managerial: Accounting

Focus On

VARIABLE AND ABSORPTION COSTING

After studying this focus unit, you should be able to meet the following learning objectives (LO).

1. Explain the difference between variable costing and absorption costing.
2. Calculate operating income under variable costing and absorption costing.

The Pitch

Kathy Stewart, CEO of Bradley Textile Mills, couldn't understand why predicting income from one period to the next was so difficult. She had been told by her accounting staff that a yard of fabric costs $3.60 to make. At a selling price of $4.00 per yard, she figured the company should make $0.40 on each yard sold. But every month when she ran the numbers, the actual results never seemed to match her predictions.

Kathy confronted CFO Michael Schwaig. “Either it costs $3.60 to make a yard of fabric or it doesn't,” she said. “How can I predict sales and costs accurately from one period to the next?” “Income depends on how much we produce and how much we sell,” Mike responded. “We've discussed variable and fixed costs before. If we ramp up production and spread our fixed costs over more yards of fabric, we can reduce the cost to produce each yard and increase our margin. Producing more units ...