Abstract Managerial accounting texts generally limit discussion of the difference between absorption costing (AC) and direct costing (DC) net income to the simplest case were the fixed manufacturing overhead cost per unit does not change from period to period and any under/over applied overhead is written off to cost of sales. Consequently, the textbook reconciliation rule fails when these assumptions are violated. We present a general rule, of which the familiar textbook formulation is a special case. Second, textbooks generally discuss cost-volume-profit (CVP) analysis only in a DC context . We extend CVP analysis to the AC setting and show why DC-based CVP analysis used for internal planning does not translate well to AC figures typically used in external reporting. Certain peculiarities of the behavior of AC net income are traced to the role played by the level of production. Numerical examples clarify the various general formulations derived.
Bipin et al. (Mon,) studied this question.