This week, we learned that there are two different ways of reporting the contribution margins (profitability) – variable and absorption costing. The authors made a point that one method is more useful for internal purposes, and the other is more useful for external reporting.
Let’s think about a company that produces dinner ware (plates, bowls, cups and saucers, for example). Some of the dinner ware is intended for daily use (stoneware that is dishwasher and microwave safe), and other dinner ware is for special occasion (fine china or bone china, with gold trim that cannot go in the microwave!) Daily use dinnerware is less expensive than special occasion dinnerware. Imagine that there is consistent demand year-round for the “daily use” dinnerware, but there are seasonal spikes in demand for the “special occasion” dinnerware (i.e. wedding season and the holiday season). Additionally, gold is an important component of special use dinner ware, yet the price of gold varies.
Explain how fixed manufacturing overhead costs are shifted from one period to another under absorption costing.
What arguments are there in favor of treating fixed manufacturing overhead costs as product costs? As period costs?
Under absorption costing, how is it possible to increase net operating income without increasing sales? Explain.