Which of the following statements is true regarding absorption costing? Fixed overhead is included in period expenses under absorption costing. It is not permitted to be used for financial reporting. It is not permitted to be used for tax reporting. It assigns all manufacturing costs to products. It requires only variable costs to be treated as product costs. QUESTION 22 Which of the following statements is true? Under variable costing, direct materials and direct labor are expensed as period expenses. Under variable costing, fixed overhead is expensed as a period expense. Fixed overhead costs are treated the same under both absorption costing and variable costing. Reported income under absorption costing is not affected by production level changes. Under absorption costing, fixed overhead is expensed as a period expense.
The correct answer and explanation is:
Correct Answer for Question 1:
“It assigns all manufacturing costs to products.”
Explanation:
Absorption costing, also known as full costing, is a costing method in which all manufacturing costs (both variable and fixed) are assigned to the cost of a product. This includes direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead. Unlike variable costing, which only assigns variable manufacturing costs to products and treats fixed manufacturing overhead as a period expense, absorption costing spreads fixed overhead costs across all units produced.
This method is required for external financial reporting under Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) because it provides a more comprehensive view of production costs. It is also permitted for tax reporting, as tax authorities in many countries, including the United States (IRS), accept absorption costing.
Absorption costing can impact financial statements because inventory costs include fixed overhead, meaning that when inventory is unsold, some fixed overhead costs remain in the balance sheet rather than being expensed immediately. This can lead to higher reported income when production exceeds sales, as some costs are deferred to future periods.
Correct Answer for Question 2:
“Under variable costing, fixed overhead is expensed as a period expense.”
Explanation:
Variable costing, also known as direct costing, treats only variable manufacturing costs (direct materials, direct labor, and variable manufacturing overhead) as product costs. Fixed manufacturing overhead is not assigned to products and instead is treated as a period expense, meaning it is expensed in full during the period incurred.
This method differs from absorption costing, where fixed overhead costs are included in the cost of inventory and only expensed when the inventory is sold. Because of this difference, reported income under variable costing can be lower when production exceeds sales, as fixed costs are not deferred in inventory.
Variable costing is not permitted for external financial reporting under GAAP or IFRS but is often used for internal decision-making, as it provides a clearer picture of how changes in production volume impact profitability. It is useful for break-even analysis, contribution margin calculations, and cost control measures.
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