Accounting Q&A · Cost and Management Accounting · Topic 12
Work through the questions, then reveal the answers to check your reasoning.
25 short-answer questions. Try each question before revealing its answer.
Worked example
Fixed production overhead is 20,000 for 10,000 units. With no opening inventory and 1,000 unsold units, absorption profit is 2,000 higher than variable costing profit in this simplified case.
See IAS 2 Inventories for financial reporting requirements.
Core concepts
1. What is absorption costing?
Inventory production cost includes allocated fixed and variable production overhead.
2. What is variable costing?
Inventory production cost includes variable production costs. Fixed production overhead is expensed for the period.
3. What is marginal costing in many textbooks?
A method treating variable costs as product or activity costs and fixed costs as period costs.
4. What is contribution?
Sales less variable costs.
5. What is gross profit in an absorption statement?
Sales less absorption cost of goods sold.
6. What causes profit to differ between methods?
Fixed production overhead can be carried in or released from inventory under absorption costing.
7. When is absorption profit often higher?
When inventory increases at a stable fixed overhead rate, all else equal.
8. When can variable costing profit be higher?
When inventory decreases and absorption costing releases more fixed overhead from inventory than it defers.
9. When can the two profit figures agree?
When the fixed overhead carried in inventory does not change and other treatments agree.
10. How does variable selling commission affect inventory?
It is a selling cost, generally excluded from production inventory under both methods.
Worked applications
11. Variable production cost is 8 and fixed overhead allocation is 3 per unit. What is absorption unit cost?
11.
12. What is the variable production unit cost in that example?
8.
13. How much fixed overhead is in 600 closing units at 3 each?
1,800.
14. Opening inventory contains 900 of fixed overhead and closing contains 1,800. What is the profit difference?
Absorption profit is 900 higher, assuming other treatments agree.
15. What if closing inventory contains 500 and opening contains 900?
Absorption profit is 400 lower under the same assumptions.
16. Sales are 50,000 and variable costs are 30,000. What is contribution?
20,000.
17. Fixed costs are 14,000. What is variable costing profit?
6,000, assuming no other items.
18. Fixed production overhead is 60,000 at normal capacity of 20,000 units. What is the normal rate?
3 per unit.
19. Can low output justify increasing the IAS 2 rate per unit to absorb all fixed overhead?
IAS 2 uses normal capacity and expenses unallocated fixed overhead from low production.
Review and exam practice
20. Why is variable costing useful for short-term analysis?
It presents contribution and separates fixed costs for further relevance checks.
21. Can every fixed cost be ignored in a short-term decision?
A fixed cost can be relevant if accepting an option changes it.
22. Why can overproduction increase absorption profit temporarily?
More fixed overhead may remain in unsold inventory instead of being expensed immediately.
23. How can management discourage unnecessary production?
Track inventory, demand and cash, and avoid relying on absorption profit alone.
24. How do you reconcile the two profit figures?
Add closing inventory fixed overhead and subtract opening inventory fixed overhead from variable costing profit, allowing for other treatment differences.
25. Which costs should be checked before comparing statements?
Check selling costs, fixed overhead treatment, inventory rates and volume assumptions.