Inventory Valuation under Absorption Costing and Variable Costing

At the end of the first year of operations, 18,000 units remained in the finished goods inventory. The unit manufacturing costs during the year were as follows:

Line Item DescriptionCostDirect materials

$25

Direct labor

20

Fixed factory overhead

30

Variable factory overhead

5

Determine the cost of the finished goods inventory reported on the balance sheet under (a) the absorption costing concept and (b) the variable costing concept.

To determine the cost of the finished goods inventory under both **absorption costing** and **variable costing**, we need to calculate the unit cost under each method and then apply that to the 18,000 units of finished goods inventory.

### Step 1: Define Costs for Absorption Costing and Variable Costing
1. **Direct Materials**: $25
2. **Direct Labor**: $20
3. **Fixed Factory Overhead**: $30
4. **Variable Factory Overhead**: $5

### Step 2: Calculate Unit Cost Under Each Costing Method

#### (a) Absorption Costing
Under **absorption costing**, all manufacturing costs (direct materials, direct labor, fixed factory overhead, and variable factory overhead) are included in the unit cost.

\[
\text{Total Unit Cost under Absorption Costing} = \text{Direct Materials} + \text{Direct Labor} + \text{Fixed Factory Overhead} + \text{Variable Factory Overhead}
\]

\[
= 25 + 20 + 30 + 5 = 80
\]

So, the **unit cost under absorption costing** is $80.

Now, we apply this to the finished goods inventory:

\[
\text{Finished Goods Inventory Cost (Absorption Costing)} = \text{Unit Cost} \times \text{Units in Inventory}
\]

\[
= 80 \times 18,000 = 1,440,000
\]

#### (b) Variable Costing
Under **variable costing**, only variable manufacturing costs (direct materials, direct labor, and variable factory overhead) are included in the unit cost. Fixed factory overhead is treated as a period cost and not included in the inventory valuation.

\[
\text{Total Unit Cost under Variable Costing} = \text{Direct Materials} + \text{Direct Labor} + \text{Variable Factory Overhead}
\]

\[
= 25 + 20 + 5 = 50
\]

So, the **unit cost under variable costing** is $50.

Now, we apply this to the finished goods inventory:

\[
\text{Finished Goods Inventory Cost (Variable Costing)} = \text{Unit Cost} \times \text{Units in Inventory}
\]

\[
= 50 \times 18,000 = 900,000
\]

### Summary

1. **Absorption Costing Finished Goods Inventory**: $1,440,000
2. **Variable Costing Finished Goods Inventory**: $900,000

Let me know if you need more details on any part of the calculation or if you have other questions!

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#### Related Questions
1. How does the treatment of fixed costs differ between absorption and variable costing?
2. What impact does inventory level have on net income under absorption costing?
3. How would the inventory cost change if fixed factory overhead increased?
4. Why might a business prefer absorption costing for financial reporting?
5. What adjustments are needed to convert between variable and absorption costing?

#### Tip
Absorption costing typically shows higher inventory values because it includes all manufacturing costs, while variable costing only includes variable costs, providing a lower inventory valuation.

Inventory Valuation under Absorption Costing and Variable Costing: At the end of the first year of operations, 18,000 units remained in the finished goods inventory. The unit manufacturing costs during the year were as follows: Direct materials: $25, Direct labor: $20, Fixed factory overhead: $30, Variable factory overhead: $5. Determine the cost of the finished goods inventory reported on the balance sheet under (a) the absorption costing concept and (b) the variable costing concept.

Learn how to calculate the finished goods inventory value under both absorption and variable costing methods. This detailed example covers costs like direct materials, direct labor, and factory overhead for 18,000 units, helping students understand key accounting concepts.

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