Measuring and Assigning Costs for Income Statements is an outstanding task that assumes incredible importance in tody´s organizations.
The methods are similar because they assign some costs to inventory as product costs, and expense other costs as period costs. The three methods differ in the categories that are used for product and period costs. Details of these categorizations follow.
Absorption costing allocates all production costs, both fixed and variable, to units as product costs so cost of goods sold and inventory on the balance sheet include fixed no volume variances.
Under variable costing, all fixed manufacturing overhead is treated as an expense of the period, regardless of how many units were produced or sold; income will vary only with the number of units sold, the level of production has no effect. Under absorption costing, fixed manufacturing overhead is first assigned to product; the amount of fixed overhead that appears on the income statement depends on unit sales. Income depends upon both the level of production and the level of sales.
Eventually all of the units are sold under either method, so eventually all of the fixed manufacturing cost will be expensed under either method. Under variable costing, it is expensed during the period it is incurred, whereas under absorption costing, a portion of fixed manufacturing cost is inventoried and expensed when the inventory is sold rather than during the period it was incurred.
Supply-based capacity levels measure the amount of capacity that is available for production. Theoretical capacity and practical capacity are supply based. Demand-based capacity levels measure the amount of capacity needed to meet sales volumes. Normal capacity and budgeted capacity are demand based.
Theoretical capacity is the maximum number of units that would be produced under
continuous,