Income Statements:
Variable Cost vs Absorption Cost
Self Test
Self Test
Click the “Check Your Answer” box below each question to reveal the correct answer and explanation.
1. Variable cost can not be used for
a. internal reporting
b. external reporting
c. reporting to the sales manager
d. reports used at the monthly management meeting
Answer
B. Variable cost is not in accordance with GAAP and can not be used for external reporting. GAAP requires all manufacturing costs to be product/inventory costs and variable cost treats fixed manufacturing overhead as a period cost. It is used for internal reporting, which also include sales and other managers.
2. Income using variable cost and income using absorption cost will be the same when
a. sales are the same
b. the volume of production is the same for both
c. finished goods inventory does not change for the current period
d. raw materials inventory does not change for the current period
Answer
C. The difference in the two statements is the fixed manufacturing overhead in the change in inventory on the balance sheet. When inventory does not change, there is no difference. The statements are for the same company so sales and production will always be the same. Raw materials inventory does not impact either income statement, it impacts the balance sheet only.
3. An accountant who prepares a variable cost income statement must know
a. the difference between product and period costs
b. the difference between fixed and variable costs
c. how to identify period expenses
d. what GAAP requires for the income statement
Answer
B. A variable cost income statement is sorted by variable and fixed costs. For this statement, it does not matter if a cost is period or product. This statement is not in accordance with GAAP.
4. Product costs, also called inventory costs, under variable cost include
a. variable production costs only
b. variable and fixed production costs
c. fixed production costs only
d. all production costs plus fixed administrative
Answer
5. Product costs, also called inventory costs, under absorption cost include
a. variable production costs only
b. variable and fixed production costs
c. fixed production costs only
d. all production costs plus fixed administrative
Answer
B. Under absorption cost, product costs include ALL manufacturing costs, both fixed and variable. Administrative and Selling are always considered period costs.
6. A variable cost income statement is different from an absorption cost income statement in which of the following ways?
a. Period costs are not reported on the absorption cost income statement
b. Fixed manufacturing overhead is a product cost under absorption cost
c. Fixed manufacturing overhead is a product cost under variable cost
d. Period costs are included as part of cost of goods sold under absorption cost
Answer
B. The difference in the two statements is how fixed manufacturing overhead is treated. It is a period cost under variable cost and a product cost under absorption cost. Period costs are never considered to be a product cost.
7. A term used that means the same thing as absorption cost is
a. full cost
b. direct cost
c. indirect cost
d. product cost
Answer
A. Full cost is another term that means the same thing as absorption cost. Full cost means that all product costs are considered in determining the cost of the product, including fixed manufacturing overhead.
8. Which of the following will not be reported on the absorption cost income statement?
a. contribution margin
b. period expenses
c. gross profit
d. manufacturing overhead
Answer
A. Contribution margin is determined by considering subtracting variable costs from sales. It is the profit available to cover fixed costs. An absorption cost statement does not sort by variable and fixed, so contribution margin is not reported. Period expenses and manufacturing overhead is reported on both statements, in different places.
9. Which of the following will not be reported on the variable cost income statement?
a. contribution margin
b. period expenses
c. gross profit
d. manufacturing overhead
Answer
C. Variable cost does not report gross profit. Gross profit is determined by subtracting all product costs from sales. Variable cost does not consider fixed manufacturing overhead to be a product cost, so you do not see a subtotal for “less all product costs.” Product costs are reported in two different places. Period expenses and manufacturing overhead is reported on both statements, in different places.
10. Which cost is not reported in the same way on a variable cost income statement and on an absorption cost income statement?
a. Administrative costs
b. Variable Production costs
c. Fixed production costs
d. Selling costs
Answer
C. Fixed production costs are reported as a period cost for variable cost and as a product cost for absorption cost. All other costs listed are treated and reported the same on both statements.
11. The difference between absorption cost income and variable cost income is caused by
a. the format used for each income statement
b. period costs
c. manufacturing overhead
d. variable costs
Answer
C. Manufacturing overhead is the only fixed production costs. Fixed production costs are reported as a period cost for variable cost and as a product cost for absorption cost. All other costs listed are treated and reported the same on both statements. The format does not cause the income to be different, putting different amounts of fixed manufacturing overhead on the statements causes the difference.
12. The variable cost income statement is most often used by managers because it
a. shows how income is affected by cost behavior
b. includes all costs and the absorption cost statement does not
c. is required under GAAP
d. always gives a lower cost and a higher income
Answer
A. The variable cost income statement sorts all costs by variable and fixed. This is the same thing as cost behavior. It shows how profit will be affected by changes in volume since variable costs change and fixed costs do not change. It is not acceptable under GAAP. Both statements report the same costs at the same amount with the exception of fixed manufacturing overhead. A lower or higher income is determined by what direction finished goods inventory changes and variable cost does not always give a higher income.
13. Variable cost is not in accordance with GAAP because
a. variable costs are not reported in accordance with GAAP
b. income is always higher under variable cost
c. variable manufacturing costs are treated as product costs
d. fixed manufacturing costs are treated as period costs
Answer
D. Variable cost treats fixed manufacturing overhead as a period cost. Under GAAP it is a product cost because it is a cost of making the product. Variable costs are treated as product costs which is in accordance with GAAP. Income will not be higher under variable cost when inventory is increasing.
14. The line that separates variable and fixed costs on a variable cost income statement is called
a. gross profit
b. operating income before fixed costs
c. contribution margin
d. net variable costs
Answer
C. Contribution margin is the amount that is available after variable costs to cover fixed costs. Gross profit is reported on an absorption cost statement. Operating income is after fixed costs, not before. There is no such term as net variable costs.
15. An absorption cost income statement will report higher income than a variable cost income statement when
a. inventory levels decrease
b. inventory levels increase
c. variable costs are lower than on the absorption cost income statement
d. the company sells the same amount of inventory it produced
Answer
B. Absorption cost income is higher than variable cost when inventory increases. It is higher when inventory increases because the fixed costs of producing the additional inventory is in inventory on the balance sheet rather than as an expense on the income statement. Higher income means there is less reported fixed manufacturing overhead expenses. When inventory decreases, the opposite occurs. Costs move from the balance sheet to the income statement when sold, and higher costs leads to less income. Variable costs are always reported at the same amount on both statements.