So let us pretend that I've got some numbers and I'll put them on this side.
So let's say over here I've got direct materials, direct labor, variable overhead, fixed overhead.
Absorption and direct, okay.
Let's say I've got $2.00 of direct materials.
I've got a $1.25 of direct labor.
I've got $.75 of variable overhead.
And I have $1.20 of fixed overhead.
This is for absorption purposes.
Now, where did this fixed overhead come from?
Let's pretend that my fixed overhead is $120,000 a year, maybe it's rent.
Now, I am going to manufacture 100,000 units.
That equals $1.20 a unit.
So, that is how much per unit is fixed overhead.
Okay, now under absorption costing, it's called absorption because whatever doesn't get sold
that part of the overhead will get absorbed into ending inventory.
It doesn't get expensed it gets absorbed into ending inventory.
So that's what�s going to happen.
Now, under direct, direct materials.
Still the same, that gets put into ending inventory.
Direct labor, that's going to get put into ending inventory.
Variable overhead, that's gonna get put into ending inventory.
But the question is what an inventoriable cost?
Well, of the fixed overhead under direct variable prime we're only going to capitalize the variable
costs.
What are variables?
Materials variable, labor variable, variable overhead is variable.
What about fixed overhead?
Fixed is a sunk cost.
So as far as direct prime contribution here, what they're gonna do here is they're going
to expense all $120,000.
All 120 gets expensed.
So, over here how much gets inventoried?
None of it.
When I talk about how much is my inventoriable cost per unit This would be two, 325, four,
520.
This is two, three, four dollars.
The difference is what?
The $1.20 that here got absorbed into ending here got expensed.
Let's say for example that my production was 100,000 units, but my sales were only 80,000
units.
That means ending inventory's gonna go up by 20,000 units.
Everybody see that?
So that's whats going to happen.
Ending inventory is going to go up.
Now, what happens is if I sold 80,000 units.
What's going to happen under absorption?
What does GAP say?
GAP says your costs are going to be 80 at $1.20 is $96,000.
So over here I'm going to expense fixed costs of goods sold is going to be 96,000.
Here it's going to be what?
120,000.
Notice what is the difference between 96 and 120.
Well, I'll show you an easier way to figure this out.
What's the difference between what I produced and what I sold?
Ending inventory went up by 20,000 dollars or 20,000 units.
20,000 Units at a $1.20 a unit is $24,000.
I bet you that is the difference in this.
What's 120 minus 24?
96 So the profit difference between these two is going to be what?
The 20,000 units in ending times the $1.20 of your fixed overhead which is $24,000.
That's going to be difference in the profit between these two methods.
Why?
Because under GAP you can't expense it till you sell it.
So I spend 120,000 on rent but I need to allocate that a $1.20 a unit times the units sold and
the units in ending.
The stuff I sold was 80,000 the stuff in ending is 20,000.
So the 20,000 times 120 gets absorbed in ending.
Under direct variable prime they go "I don't really care about this."
Why?
Because the fixed cost is sunk.
I don't care, expense it.
So here they're going to expense what?
All 120 under fixed manufacturing.
That's why I call them different.
I call this fixed manufacturing costs, and I call this fixed costs of goods sold.
Because this is still based on 80,000 units this is based on all 100 because it's a sunk
cost.
It's gone, it's done, it's history.
It is his-his-history!
So, that's what we're basically saying.
That's the difference.