Landau Company

Submitted by: Submitted by

Views: 237

Words: 537

Pages: 3

Category: Business and Industry

Date Submitted: 11/17/2012 01:58 PM

Report This Essay


The Full Costing System will result in lower income (as appearing in the book) as compared to the Variable Costing System if inventory decreases (i.e. sales exceeds production not considering direct purchase of finished goods), and higher income if inventory increases. The underlying logic is that, when inventory increases, some of the fixed overhead expenditures incurred in the previous period will not be recognized as cost of goods sold during the current period nor included in the income statement; rather they will be 'carried over' as part of the inventory account, to a future period until those goods are finally sold. When inventory deceases, the cost of good sold during the current period will carry some of the fixed expenditures incurred in previous periods but only recognized as cost of sales for now.

This effect implicitly encourages high production since higher production would mean a higher income (and a higher increase in retained earnings) in the books.

Pros and Cons of the Variable Costing System as compared to the Full Costing System will be analyzed in Q4.


Variable Costing System - Pros:

- Avoids the complexities and time-consuming efforts associated with the allocation of fixed overhead to individual products. This is a negligible benefit, however, since these efforts are needed anyways for external reporting purposes.

- Removes fixed overhead from the cost, treating it as a period expense rather than part of the inventory cost. This expense can be monitored and addressed with break-even analysis based on the contribution margin concept under the Variable Costing System.

- Easier for managers to understand how manufacturing costs are being incurred.

- Therefore Variable Costing System clearly separates Fixed Overhead Management and Production Efficiency Management: To break even between fixed expenses and sales margin for some certain period, one should either reduce the overhead expense during that period, or reduce cost of sales...