Tustin LLC uses variable costing and absorption costing. Using the absorption costing income statement, fixed manufacturing overHead is
The correct answer and explanation is:
To determine fixed manufacturing overhead using the absorption costing income statement, you need to understand how absorption costing treats costs.
In absorption costing, fixed manufacturing overhead is included in the cost of goods manufactured (COGM) and therefore becomes part of the inventory cost. It’s only expensed as part of cost of goods sold (COGS) when the inventory is sold.
✅ Correct Answer:
Fixed manufacturing overhead is treated as a product cost and is included in inventory until the product is sold.
📘 300-Word Explanation:
Absorption costing, also known as full costing, is a method in which all manufacturing costs—both variable and fixed—are assigned to units of production. This contrasts with variable costing, where only variable manufacturing costs are included in product costs and fixed manufacturing overhead is treated as a period expense.
Under absorption costing, fixed manufacturing overhead is not expensed immediately. Instead, it is allocated to each unit produced during the period. This means that part of the fixed manufacturing overhead is included in the ending inventory if all units are not sold. Only the portion of fixed overhead related to the units sold appears in the income statement as part of COGS.
For example, if a company produces 10,000 units and sells 8,000, the fixed overhead allocated to the 2,000 unsold units stays on the balance sheet as inventory. The income statement under absorption costing only includes the fixed overhead for the 8,000 sold units in COGS.
This accounting treatment can lead to differences in operating income between absorption and variable costing. Specifically, when inventory increases, absorption costing reports higher net income, because some fixed overhead costs are deferred in inventory. When inventory decreases, income is lower, because previously deferred fixed costs are now expensed.
In summary, in an absorption costing income statement, fixed manufacturing overhead is part of the inventory cost, included in COGS when the inventory is sold. It is not listed separately as a period expense, as it would be under variable costing.