Compute the product cost per unit under absorption costing

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Compute the product cost per unit under absorption costing

The cost per unit is commonly derived when a company produces a large number of identical products. This information is then compared to budgeted or standard cost information to see if the organization is producing goods in a cost-effective manner.The cost per unit is derived from the variable costs

and fixed costs incurred by a production process, divided by the number of units produced. Variable costs, such as direct materials, vary roughly in proportion to the number of units produced, though this cost should decline somewhat as unit volumes increase, due to greater volume discounts. Fixed

costs, such as building rent, should remain unchanged no matter how many units are produced, though they can increase as the result of additional capacity being needed (known as a step cost, where the cost suddenly steps up to a higher level once a specific unit volume is reached). Examples of step

costs are adding a new production facility or production equipment, adding a forklift, or adding a second or third shift. When a step cost is incurred, the total fixed cost will now incorporate the new step cost, which will increase the cost per unit. Depending on the size of the step cost increase, a manager

may want to leave capacity where it is and instead outsource additional production, thereby avoiding the additional fixed cost. This is a prudent choice when the need for increased capacity is not clear.Formula for the Cost per UnitWithin these restrictions, then, the cost per unit calculation is:(Total fixed

costs + Total variable costs) ? Total units producedThe cost per unit should decline as the number of units produced increases, primarily because the total fixed costs will be spread over a larger number of units (subject to the step costing issue noted above). Thus, the cost per unit is not

constant.Example of the Cost per UnitABC Company has total variable costs of $50,000 and total fixed costs of $30,000 in May, which it incurred while producing 10,000 widgets. The cost per unit is:($30,000 Fixed costs + $50,000 variable costs) ? 10,000 units = $8 cost per unitIn the following month,

ABC produces 5,000 units at a variable cost of $25,000 and the same fixed cost of $30,000. The cost per unit is:($30,000 Fixed costs + $25,000 variable costs) ? 5,000 units = $11/unitRelated CoursesCost Accounting Fundamentals Haydee P. asked ? 04/26/19 In 2017, ABS manufacturing produced and

sold 50,000 units of "x" product in their first year. The following info is provided:Total sales: (50,000 x $80) 4,000,000Units Produced and Sold: 50,000Direct Material $35 per unitDirect labor $10 per unitVariable Overhead: $5 per unitFixed Overhead: $8 per unitSelling & admin:Variable S&A $2 per

unitFixed S&A $10 per unit1) Calculate product cost per unit under Variable & Absorption Costing:I did that, and got $58 for Absorption, and $50 for Variable.We also had to prepare the income statement under both methods, which I did.However, question 3 says the production manager of the company

would like to increase the units produced from 50,000 to 80,000 units of "x". How do I calculate the new product cost per unit under variable and absorption, as well as prepare the income statement under both methods? So far, i know that the Direct materials, labor stay the same, and I know total fixed

cost stays the same, but how does var. and fixed overhead change? HELP! thank you in advance. Absorption costing, also called full costing, is what you are used to under Generally Accepted Accounting Principles. Under absorption costing, companies treat all manufacturing costs, including both fixed

and variable manufacturing costs, as product costs. Remember, total variable costs change proportionately with changes in total activity, while fixed costs do not change as activity levels change. These variable manufacturing costs are usually made up of direct materials, variable manufacturing

overhead, and direct labor. The product costs (or cost of goods sold) would include direct materials, direct labor and overhead. The period costs would include selling, general and administrative costs. The following diagram explains the cost flow for product and period costs. The product cost, under

absorption costing, would be calculated as: Direct Materials + Direct Labor + Variable Overhead + Fixed Overhead = Total Product Cost You can calculate a cost per unit by taking the total product costs / total units PRODUCED. Yes, you will calculate a fixed overhead cost per unit as well even though

we know fixed costs do not change in total but they do change per unit. We will assign a cost per unit for accounting reasons. When we prepare the income statement, we will use the multi-step income statement format. We will not get as complicated in our multi-step income statement as the video

example but it should have provided a refresher from what you should have learning in financial accounting. For our purpose, the absorption income statement will contain: Sales ? Cost of Goods Sold = Gross Profit Operating Expenses: Selling Expenses + General and Admin. Expenses = Total

Expenses = Net Operating Income Gross Profit is also referred to as gross margin. Net operating income is Gross Profit ? Total Operating Expenses and is also called Income before taxes. Let's look at an example: Bradley Company had the following information for May: Direct materials $13,000 Direct

labor $15,000 Variable overhead $5,000 Fixed overhead $6,000 Fixed selling expenses $15,000 Variable selling expenses $0.20 per unit Administrative expenses $12,000 10,000 units produced 9,000 units sold (1,000 remain in ending finished goods inventory) Sales price $8 per unit First, we need to

calculate the absorption product cost per unit: Direct Materials $ 13,000 + Direct Labor $ 15,000 + Variable Overhead $ 5,000 + Fixed Overhead $ 6,000 = Total Product Cost $39,000 ? Total Units Produced ? 10,000 = Product cost per unit $ 3.90 Next, we can use the product cost per unit to create the

absorption income statement. We will use the UNITS SOLD on the income statement (and not units produced) to determine sales, cost of goods sold and any other variable period costs. Bradley Company Income Statement (absorption) For Month Ended May Sales (9,000 x $8 per unit) $ 72,000 ? Cost

of Goods Sold (9,000 x $3.90 per unit)

35,100 = Gross Profit

36,900 Operating Expenses: Selling Expenses (15,000 fixed + variable 0.20 x 9,000 units sold)

16,800 + General and Admin. Expenses

12,000 = Total Expenses

28,800 = Net

Operating Income $8,100 Remember the following under absorption costing: Typically used for financial reporting (GAAP) ALL manufacturing costs are included in the cost (direct materials, direct labor, fixed and variable overhead) Can be misleading as some costs are not affected by products Fixed

manufacturing overhead costs are applied to units PRODUCED and not just unit sold Income statement shows Sales ? Cost of Goods sold = Gross Margin (or Gross Profit) ? Operating Expenses = Net Income and is based on the number of units SOLD. The difference between the absorption and

variable costing methods centers on the treatment of fixed manufacturing overhead costs. Absorption costing "absorbs" all of the costs used in manufacturing and includes fixed manufacturing overhead as product costs. Absorption costing is in accordance with GAAP, because the product cost includes

fixed overhead. Variable costing considers the variable overhead costs and does not consider fixed overhead as part of a product's cost. It is not in accordance with GAAP, because fixed overhead is treated as a period cost and is not included in the cost of the product. Absorbing Costs through

Overproduction While companies use absorption costing for their financial statements, many also use variable costing for decision-making. The Big Three auto companies made decisions based on absorption costing, and the result was the manufacturing of more vehicles than the market demanded.

Why? With absorption costing, the fixed overhead costs, such as marketing, were allocated to inventory, and the larger the inventory, the lower was the unit cost of that overhead. For example, if a fixed cost of ?1,000 is allocated to 500 units, the cost is ?2 per unit. But if there are 2,000 units, the per-unit

cost is ?0.50. While this was not the only reason for manufacturing too many cars, it kept the period costs hidden among the manufacturing costs. Using variable costing would have kept the costs separate and led to different decisions. Absorption costing considers all fixed overhead as part of a product's

cost and assigns it to the product. This treatment means that as inventories increase and are possibly carried over from the year of production to actual sales of the units in the next year, the company allocates a portion of the fixed manufacturing overhead costs from the current period to future periods.

Carrying over inventories and overhead costs is reflected in the ending inventory balances at the end of the production period, which become the beginning inventory balances at the start of the next period. It is anticipated that the units that were carried over will be sold in the next period. If the units are

not sold, the costs will continue to be included in the costs of producing the units until they are sold. Finally, at the point of sale, whenever it happens, these deferred production costs, such as fixed overhead, become part of the costs of goods sold and flow through to the income statement in the period of

the sale. This treatment is based on the expense recognition principle, which is one of the cornerstones of accrual accounting and is why the absorption method follows GAAP. The principle states that expenses should be recognized in the period in which revenues are incurred. Including fixed overhead

as a cost of the product ensures the fixed overhead is expensed (as part of cost of goods sold) when the sale is reported. For example, assume a new company has fixed overhead of ?12,000 and manufactures 10,000 units. Direct materials cost is ?3 per unit, direct labor is ?15 per unit, and the variable

manufacturing overhead is ?7 per unit. Under absorption costing, the amount of fixed overhead in each unit is ?1.20 (?12,000/10,000 units); variable costing does not include any fixed overhead as part of the cost of the product. (Figure) shows the cost to produce the 10,000 units using absorption and

variable costing. Finished Goods Inventory under Absorption and Variable Costing. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license) Assume each unit is sold for ?33 each, so sales are ?330,000 for the year. If the entire finished goods inventory is sold, the income is the

same for both the absorption and variable cost methods. The difference is that the absorption cost method includes fixed overhead as part of the cost of goods sold, while the variable cost method includes it as an administrative cost, as shown in (Figure). When the entire inventory is sold, the total fixed

cost is expensed as the cost of goods sold under the absorption method or it is expensed as an administrative cost under the variable method; net income is the same under both methods. Income Statement When the Entire Inventory Is Sold. (attribution: Copyright Rice University, OpenStax, under CC

BY-NC-SA 4.0 license) Now assume that 8,000 units are sold and 2,000 are still in finished goods inventory at the end of the year. The cost of the fixed overhead expensed on the income statement as cost of goods sold is ?9,600 (?1.20/unit ? 8,000 units), and the fixed overhead cost remaining in finished

goods inventory is ?2,400 (?1.20/unit ? 2,000 units). The amount of the fixed overhead paid by the company is not totally expensed, because the number of units in ending inventory has increased. Eventually, the fixed overhead cost will be expensed when the inventory is sold in the next period. (Figure)

shows the cost to produce the 8,000 units of inventory that became cost of goods sold and the 2,000 units that remain in ending inventory. Cost of Goods Sold and Ending Inventory with the Absorption and Variable Costing Methods. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA

4.0 license) If the 8,000 units are sold for ?33 each, the difference between absorption costing and variable costing is a timing difference. Under absorption costing, the 2,000 units in ending inventory include the ?1.20 per unit share, or ?2,400 of fixed cost. That cost will be expensed when the inventory is

sold and accounts for the difference in net income under absorption and variable costing, as shown in (Figure). Net Income under Absorption and Variable Costing When Ending Inventory Remains. (attribution: Copyright Rice University, OpenStax, under CC BY-NC-SA 4.0 license) Under variable costing,

the fixed overhead is not considered a product cost and would not be assigned to ending inventory. The fixed overhead would have been expensed on the income statement as a period cost. Because absorption costing defers costs, the ending inventory figure differs from that calculated using the

variable costing method. As shown in (Figure), the inventory figure under absorption costing considers both variable and fixed manufacturing costs, whereas under variable costing, it only includes the variable manufacturing costs. Using the absorption costing method on the income statement does not

easily provide data for cost-volume-profit (CVP) computations. In the previous example, the fixed overhead cost per unit is ?1.20 based on an activity of 10,000 units. If the company estimated 12,000 units, the fixed overhead cost per unit would decrease to ?1 per unit. This calculation is possible, but it

must be done multiple times each time the volume of activity changes in order to provide accurate data, as CVP analysis makes no distinction between variable costing and absorption costing income statements. Comparing Variable and Absorption Methods A company expects to manufacture 7,000

units. Its direct material costs are ?10 per unit, direct labor is ?9 per unit, and variable overhead is ?3 per unit. The fixed overhead is estimated at ?49,000. How much would each unit cost under both the variable method and the absorption method? Solution The variable cost per unit is ?22 (the total of

direct material, direct labor, and variable overhead). The absorption cost per unit is the variable cost (?22) plus the per-unit cost of ?7 (?49,000/7,000 units) for the fixed overhead, for a total of ?29.

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