Post on 31-Mar-2015
Inventory Costing
and Capacity Analysis
JOIN KHALID AZIZECONOMICS OF ICMAP, ICAP, MA-ECONOMICS,
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Fresh classes of icmap stage 1-3Fundamentals of fa(1)
Cost accounting(2)Financial accounting(3)
Cost accounting-appraisal(3)From 22nd February, 2010
FRESH CLASSES OF MA-ECONOMICS PREVIOUS- MICRO ECONOMICS
STATISTICS FINAL – MACRO ECONOMICS
FROM 15TH FEBRUARY 2010
Learning Objective 1
Identify what distinguishesvariable costing from
absorption costing.
Inventory-Costing Methods
The difference between variable costingand absorption costing is based on the
treatment of fixed manufacturing overhead.
Variable Costing
DirectMaterials
VariableFactoryLabor
VariableOverhead
Work in Process Inventory
Variable Costing
Work in ProcessInventory
Finished GoodsInventory
Cost of Goods Sold
Income Summary
Fixed FactoryLabor
Learning Objective 2
Prepare income statementsunder absorption costing
and variable costing.
Comparing Income Statements
The following data pertain to Davenport Fixtures:
Year 1 Year 2 TotalBeginning inventory -0- 2,000 -0-Produced 10,000 11,500 21,500Sold 8,000 13,000 21,000Ending inventory 2,000 500 500
Comparing Income Statements
The following information is on a per unit basis:
Sales price: Rs71.00
Variable manufacturing costs:Direct materials: Rs 4.00Direct manufacturing labor: Rs21.00Indirect manufacturing costs: Rs24.00
Fixed manufacturing costs: Rs 4.50
Comparing Income Statements(Absorption Costing)
Total fixed production costs are Rs54,000at a normal capacity of 12,000 units.
Fixed nonmanufacturing costs areRs30,000 per year.
Variable nonmanufacturing costs areRs2.00 per unit sold.
Comparing Income Statements(Absorption Costing)
Revenues Rs568,000Cost of goods sold 428,000Volume variance (U) 9,000
Gross margin Rs131,000Nonmanufacturing costs 46,000
Operating income Rs 85,000
Comparing Income Statements(Absorption Costing)
Revenues for Year 1 are Rs568,000.
What is the cost of goods sold?
8,000 × Rs49 = Rs392,000
What is the manufacturing contribution margin?
Rs568,000 – Rs392,000 = Rs176,000
Net contribution margin = Rs160,000
Comparing Income Statements (Variable Costing)
Revenues Rs568,000Cost of goods sold 392,000Variable nonmanufacturing costs 16,000
Contribution margin Rs160,000Fixed manufacturing costs 54,000Fixed nonmanufacturing costs 30,000
Operating income Rs 76,000
Learning Objective 3
Explain differences in operatingincome under absorption
costing and variable costing.
Operating Income(Absorption Costing)
What are revenues for Year 2?
13,000 × Rs71 = Rs923,000
What is the cost of goods sold?
13,000 × Rs53.50 = Rs695,500
Is there a volume variance?
(12,000 – 11,500) × Rs4.50 = Rs2,250underallocated fixed manufacturing costs
Operating Income(Absorption Costing)
What is the gross margin?
Rs923,000 – (Rs695,500 + Rs2,250) = Rs225,250
What are the nonmanufacturing costs?
13,000 units sold × Rs2.00 = Rs26,000variable costs + Rs30,000 fixed costs = Rs56,000
Operating Income(Absorption Costing)
What is the operating income before taxes?
Rs225,250 – Rs56,000 = Rs169,250
What is the operating income for thetwo years combined?
Rs85,000 + Rs169,250 = Rs254,250
Income Statements (Absorption Costing)
Year 1 Year 2 CombinedRevenues Rs568,000 Rs923,000 Rs1,491,000
Cost of goods sold 428,000 695,500 1,123,500Volume variance (U) 9,000 2,250 11,250
Gross margin Rs131,000 Rs225,250 Rs 356,250Nonmfg. costs 46,000 56,000 102,000
Operating income Rs 85,000 Rs169,250 Rs 254,250
Operating Income(Variable Costing)
Revenues for Year 2 are Rs923,000.
What is the cost of goods sold?
13,000 × Rs49 = Rs637,000
What is the manufacturing contribution margin?
Rs923,000 – Rs637,000 = Rs286,000
Operating Income(Variable Costing)
What is the net contribution margin?
Rs286,000 – Rs26,000 variable nonmanufacturing costs= Rs260,000 net contribution margin
What is the operating income before taxes?
Rs260,000 – Rs54,000 fixed manufacturing costs– Rs30,000 fixed nonmanufacturing costs = Rs176,000
Income Statements(Variable Costing)
Year 1 Year 2 CombinedRevenues Rs568,000 Rs923,000 Rs1,491,000Cost of goods sold 392,000 637,000 1,029,000Mfg. contr. margin Rs176,000 Rs286,000 Rs 462,000Variable nonmfg. 16,000 26,000 42,000Net contr. margin Rs160,000 Rs260,000 Rs 420,000
Income Statements(Variable Costing)
Year 1 Year 2 CombinedNet contr. margin Rs160,000 Rs260,000 Rs420,000Fixed mfg. costs 54,000 54,000 108,000Fixed nonmfg. costs 30,000 30,000 60,000Operating income Rs 76,000 Rs176,000 Rs252,000
Comparison of Variableand Absorption Costing
Variable costing operating income Year 1: Rs76,000
Absorption costing operating income Year 1: Rs85,000
Absorption costing operating income is Rs9,000 higher.
Why?
Comparison of Variableand Absorption Costing
Production exceeds sales in Year 1.
The 2,000 units in ending inventoryare valued as follows:
Absorption costing: 2,000 × Rs53.50 =Rs107,000
Variable costing: 2,000 × Rs49.00 = Rs 98,000
Difference: Rs 9,000
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Comparison of Variableand Absorption Costing
Variable costing operating income Year 2: Rs176,000
Absorption costing operating income Year 2: Rs169,250
Variable costing operating income is Rs6,750 higher.
Why?
Comparison of Variableand Absorption Costing
Sales exceeded units produced in Year 2.
13,000 – 11,500 = 1,500 decrease in inventory
Absorption costing: 1,500 × Rs53.50 = Rs80,250
Variable costing: 1,500 × Rs49.00 = Rs73,500
Higher cost of goods sold underabsorption costing: Rs 6,750
Comparison of Variableand Absorption Costing
Variable costing combined net income: Rs252,000
Absorption costing combined net income: Rs254,250
Absorption costing is higher by Rs2,250
500 units in inventory × Rs4.50 = Rs2,250
Comparison of Variableand Absorption Costing
Absorption costingoperating income
Variable costingoperating income
Fixed manufacturingcosts in endinginventory under
absorption costing
Fixed manufacturingcosts in beginninginventory under
absorption costing
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EQUALS
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Learning Objective 4
Understand how absorptioncosting can provide undesirable
incentives for managers tobuild up finished goods inventory.
Inventory Buildup
What is the production volume variance?
(12,000 – 4,400) × Rs4.50 = Rs34,200 U
What is the net operating income or lossfor the period?
Assume that Davenport Fixtures produced4,400 units in Year 1 and sold 4,100.
Inventory Buildup
Revenues (4,100 × Rs71) Rs291,100Cost of goods sold (4,100 × Rs53.50) 219,350Volume variance 34,200
Gross margin Rs 37,550Nonmanufacturing costs 38,200
Net loss Rs 650
Inventory Buildup
4,400 – 4,100 = 300
How much cost is in ending inventory?
300 × Rs53.50 = Rs16,050
How many units are in ending inventory?
Inventory Buildup
Sales remain the same (4,100 units).
What is the volume variance?
(12,000 – 9,000) × Rs4.50 = Rs13,500 U
Suppose that management decides toproduce 9,000 units next year.
What is the operating income or loss?
Inventory Buildup
Revenues (4,100 × Rs71) Rs291,100Cost of goods sold (4,100 × Rs53.50) 219,350Volume variance 13,500Gross margin Rs 58,250Nonmanufacturing costs 38,200Net income Rs 20,050
Inventory Buildup
300 + 9,000 – 4,100 = 5,200
How much cost is in ending inventory?
5,200 × Rs53.50 = Rs278,200
How many units are in ending inventory?
Learning Objective 5
Differentiate throughputcosting from variable costing
and absorption costing.
Throughput Costing
Revenues Rs568,000Variable direct materials cost of goods sold 32,000Throughput contribution margin Rs536,000Manufacturing costs 504,000Nonmanufacturing costs 46,000Operating loss Rs 14,000
Throughput Costing
Manufacturing Costs:Labor Rs21.00 × 10,000 Rs210,000Indirect costs Rs24.00 × 10,000 240,000Fixed costs 54,000
Total manufacturing costs Rs504,000
What are other nonmanufacturing costs for the year?
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Throughput Costing
Nonmanufacturing Costs:Variable Rs2.00 × 8,000
Rs16,000Fixed 30,000
Total Rs46,000
Throughput Costing
Variable costing operating income: Rs76,000Throughput costing operating loss: Rs14,000Difference in operating income: Rs90,000
How can this difference be explained?
Throughput Costing
The 2,000 units in ending inventoryare valued as follows:
Variable2,000 × Rs49 = Rs98,000
Throughput2,000 × Rs4 = Rs8,000
Rs90,000 difference
Throughput Costing
Absorption costing operating income:Rs85,000Throughput costing operating loss: Rs14,000
Difference in operating income: Rs99,000
How can this difference be explained?
Throughput Costing
The 2,000 units in ending inventoryare valued as follows:
Absorption2,000 × Rs53.50 =
Rs107,000
Throughput2,000 × Rs4= Rs8,000
Rs99,000 difference
Comparison of InventoryCosting Methods
Actual CostingActual Costing
AbsorptionCosting
AbsorptionCosting
ThroughputCosting
ThroughputCosting
VariableCostingVariableCosting
Comparison of InventoryCosting Methods
Normal CostingNormal Costing
AbsorptionCosting
AbsorptionCosting
ThroughputCosting
ThroughputCosting
VariableCostingVariableCosting
Comparison of InventoryCosting Methods
Standard CostingStandard Costing
AbsorptionCosting
AbsorptionCosting
ThroughputCosting
ThroughputCosting
VariableCostingVariableCosting
Learning Objective 6
Describe the variouscapacity concepts
that can be used inabsorption costing.
Alternative Denominator-LevelConcepts
Theoretical capacity
Practical capacity
Normal capacity
Master-budget capacity
Budgeted Fixed ManufacturingOverhead Rate
RUSTAM’s Bicycles produces bicycle partsfor domestic and foreign markets.
Fixed overhead costs are Rs200,000 within therelevant range of the various capacity volume.
Budgeted Fixed ManufacturingOverhead Rate
Assume that the theoretical capacity is10,000 machine-hours, practical capacity
is 85%, normal capacity is 75%, andmaster-budget capacity is 60%.
What is the budgeted fixed manufacturingoverhead rate at the various capacity levels?
Budgeted Fixed ManufacturingOverhead RateTheoretical 100%:
Rs200,000 ÷ 10,000 = Rs20.00/machine-hour
Practical 85%:Rs200,000 ÷ 8,500 = Rs23.53/machine-hour
Normal 75%:Rs200,000 ÷ 7,500 = Rs26.67/machine-hour
Master-budget 60%:Rs200,000 ÷ 6,000 = Rs33.33/machine-hour
Learning Objective 7
Understand the major factorsmanagement considers in choosing
a capacity level to compute thebudgeted fixed overhead cost rate.
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Choosing a Capacity Level
What factors are consideredin choosing a capacity level?
Productcosting
Pricingdecision
Performanceevaluation
Financialstatements
Regulatoryrequirements
Difficulty
Decision Making
Assume that RUSTAM’s Bicycles’ standardhours are 2 hours per unit.
What is the budgeted fixed manufacturingoverhead cost per unit?
Decision Making
Theoretical capacity: Rs20 × 2 = Rs40.00
Practical capacity: Rs23.53 × 2 = Rs47.06
Normal capacity: Rs26.67 × 2 = Rs53.34
Master-budget capacity: Rs33.33 × 2 = Rs66.66
Learning Objective 8
Describe how attempts torecover fixed costs of capacity
may lead to price increasesand lower demand.
Downward Demand Spiral
The downward demand spiral is the continuingreduction in demand that occurs when the pricesof competitors are not met and demand drops.
Learning Objective 9
Explain how the capacitylevel chosen to calculate
the budgeted fixed overheadcost rate affects the
production-volume variance.
Effect on Financial Statements
Assume that RUSTAM’s Bicycles actually used8,400 machine-hours during the year.
What is the production volume variance?
Production Volume Variance
Production volume variance= (Denominator level – Actual level)
× Budgeted fixed manufacturing overhead rate
Theoretical capacity:(10,000 – 8,400) × Rs20.00 = Rs32,000 U
Practical capacity:(8,500 – 8,400) × Rs23.53 = Rs2,353 U
Production Volume Variance
Normal capacity:(7,500 – 8,400) × Rs26.67 = Rs24,003
Master-budget capacity:(6,000 – 8,400) × Rs33.33 = Rs79,992
JOIN KHALID AZIZECONOMICS OF ICMAP, ICAP, MA-ECONOMICS,
B.COM.FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4
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MODULE D, BBA, MBA & PIPFA.
CONTACT:0322-33857520312-2302870
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN