© John Wiley & Sons, 2005 Chapter 14: Measuring and Assigning Costs for Income Statements Eldenburg...

© John Wiley & Sons, 2005 Chapter 14: Measuring and Assigning Costs for Income Statements

Eldenburg & Wolcott’s Cost Management, 1e Slide # 1

Cost ManagementMeasuring, Monitoring, and Motivating Performance

Prepared byPrepared byGail KaciubaGail Kaciuba

Midwestern State UniversityMidwestern State University

Chapter 14

Measuring and Assigning Costs for Income Statements



Chapter 14: Measuring and Assigning Costs for Income Statements

Learning objectives

• Q1: How are absorption costing income statements constructed?

• Q2: What factors affect the choice of production volume measures for allocating fixed overhead?

• Q3: How are variable costing income statements constructed?

• Q4: How are throughput costing income statements constructed?

• Q5: What are the uses and limitations of absorption, variable, and throughput costing income statements?



Q1: Absorption Costing Income Statements

• Under absorption costing, fixed manufacturing overhead is an inventoriable cost.

• GAAP requires the use of absorption costing.

• Absorption costing income statements are prepared using the traditional format.• Expenses are grouped by function.• Manufacturing costs deducted above the gross margin

subtotal.• Nonmanufacturing costs deducted below the gross

margin subtotal.



Q1: Absorption Costing IncomeStatement Example

Russell Corporation produces a product that sells for $10. In 2005, there were 10,000 units in beginning finished goods inventory. The company expected to produce, and actually did produce, 80,000 units, and 62,000 units were sold. The costs incurred in 2005 are shown below. Given the cost information below, compute the inventoriable costs per unit under absorption costing.

2005Direct materials $60,000 Direct labor 128,000 Variable factory overhead 68,000 Variable non-mfg costs 55,800 Fixed mfg overhead 100,000 Fixed non-mfg costs 70,000

Direct materials $0.75 Direct labor 1.60 Variable mfg overhead 0.85 Fixed mfg overhead 1.25

$4.45



Suppose that the Russell Corporation uses the LIFO inventory method. Prepare an absorption costing income statement for 2005.

Q1: Absorption Costing IncomeStatement Example

Note that cost of goods sold is based on the 2005 per-unit manufacturing costs because:

(1) Russell is using LIFO, and

(2) production exceeded sales in 2005.

Note that cost of goods sold is based on the 2005 per-unit manufacturing costs because:

(1) Russell is using LIFO, and

(2) production exceeded sales in 2005.

Sales (# units sold @ $10) $620,000 Cost of goods sold (# units sold @ $4.45) 275,900Gross margin 344,100Nonmfg costs ($70,000 + $55,800) 125,800Operating income $218,300

Sales (# units sold @ $10) $620,000 Cost of goods sold (# units sold @ $4.45) 275,900Gross margin 344,100Nonmfg costs ($70,000 + $55,800) 125,800Operating income $218,300



Q2: Actual versus Estimated Denominator Levels

• Normal costing (chapter 5) uses an estimated, rather than an actual, denominator level for the overhead cost allocation base.

• If an actual denominator level is used, information is not timely.

• Using an estimated denominator level provides a smoothing effect, for two reasons:• Numerator reason• Denominator reason



Q2: Various Measures of Production Volume

• Supply-based measures of capacity:• The maximum possible capacity, with no

allowance for downtime, is known as theoretical capacity.

• Theoretical capacity, reduced by an allowance for normal downtime, is known as practical capacity.

• Demand-based measures of capacity:• The average use of capacity of several years

is known as normal capacity.• The anticipated use of capacity for the

upcoming year is known as budgeted capacity or expected capacity.



Q2: Effect of Denominator Volumeon the Income Statement

• When denominator volume is different than actual volume, there is a fixed overhead volume variance.

• The volume variance is the difference between budgeted fixed overhead and applied fixed overhead.

• If material, the volume variance is closed to Work in process, Finished goods, and Cost of goods sold at year-end.



Q2: Absorption Costing Income Statement & Volume Variance Example


Russell Corporation produces a product that sells for $10. In 2005, there were 10,000 units in beginning finished goods inventory. The company expected to produce 100,000 units in 2005. However, it actually produced 80,000 units and sold 62,000 units. The costs incurred in 2005 are shown below. Compute the inventoriable costs per unit under absorption costing.

Direct materials $0.75 Direct labor $1.60 Variable mfg overhead $0.85 Fixed mfg overhead $1.00

$4.20

Note that choice of denominator level affects only the fixed overhead cost per unit.

Note that choice of denominator level affects only the fixed overhead cost per unit.



Q2: Absorption Costing Income Statement & Volume Variance Example

Suppose that the Russell Corporation uses the LIFO inventory method and that the volume variance is considered material. Assume that the balances in WIP, FG, and CGS, before any adjustment for the volume variance, were at a ratio of 1:2:7 at 12/31/05. There was no fixed overhead spending variance in 2005. Compute the volume variance and prepare the year-end entry to close the Fixed overhead control account.

Note that the unfavorable volume variance equals the underapplied fixed overhead because there was no spending variance for fixed overhead.Note that the unfavorable volume variance equals the underapplied fixed overhead because there was no spending variance for fixed overhead.

Budgeted fixed overhead $100,000Fixed overhead applied (80,000 units x $1/unit) 80,000Unfavorable fixed overhead volume variance $20,000

Fixed overhead control 20,000Work in process [(1/10) x 20,000] 2,000Finished goods [(2/10) x 20,000] 4,000Cost of good sold [(7/10) x 20,000] 14,000



Q2: Absorption Costing Income Statement& Volume Variance Example

Using the cost information on slide #8 and the volume variance you calculated on the prior slide, prepare an absorption costing income statement for 2005.

Sales (# units sold @ $10) $620,000 Cost of goods sold: (# units sold @ $4.20) $260,400 Adjustment for volume variance 14,000 274,400Gross margin 345,600Nonmfg costs ($70,000 + $55,800) 125,800Operating income $219,800

Sales (# units sold @ $10) $620,000 Cost of goods sold: (# units sold @ $4.20) $260,400 Adjustment for volume variance 14,000 274,400Gross margin 345,600Nonmfg costs ($70,000 + $55,800) 125,800Operating income $219,800



Q3: Variable Costing Income Statements

• Under variable costing, fixed manufacturing overhead is a period cost.

• Variable costing income statements are used internally only.

• Variable costing income statements are prepared using the contribution format.

• Expenses are grouped by cost behavior.• Variable costs deducted above the contribution margin

subtotal.• Fixed costs deducted below the contribution margin

subtotal.



Q3: Variable Costing Income Statement Example

Russell Corporation produces a product that sells for $10. In 2005, there were 10,000 units in beginning finished goods inventory. The company expected to produce, and actually did produce, 80,000 units, and 62,000 units were sold. The costs incurred in 2005 are shown below. Compute the inventoriable costs per unit under variable costing.


Direct materials $0.75 Direct labor 1.60 Variable mfg overhead 0.85

$3.20



Suppose that the Russell Corporation uses the LIFO inventory method. Prepare a variable costing income statement for 2005.


Note that cost of goods sold is based on the 2005 per-unit manufacturing costs because Russell is using LIFO.

Note that cost of goods sold is based on the 2005 per-unit manufacturing costs because Russell is using LIFO.

Sales (# units sold @ $8) $620,000 Variable costs:Cost of goods sold (# units sold @ $3.20) 198,400Nonmfg variable costs 55,800Contribution margin 365,800Fixed costs:Fixed mfg overhead 100,000Fixed nonmfg costs 70,000Operating income $195,800

Sales (# units sold @ $8) $620,000 Variable costs:Cost of goods sold (# units sold @ $3.20) 198,400Nonmfg variable costs 55,800Contribution margin 365,800Fixed costs:Fixed mfg overhead 100,000Fixed nonmfg costs 70,000Operating income $195,800



Suppose that the Russell Corporation uses the LIFO inventory method. Reconcile the income under variable costing you determined on the prior slide with the $218,300 income under absorption costing computed on slide #4.


Variable costing income $195,800

Add: fixed overhead attached to the increase in inventory

(18,000 units x $1.25/unit) 22,500

Absorption costing income $218, 300



Q4: Throughput Costing Income Statements

• Under throughput costing, all manufacturing costs except direct materials are period costs.

• Throughput costing income statements are used internally only; useful when most manufacturing costs are not variable in the short run.

• Throughput costing income statements are prepared using a new format.• Sales – cost of goods sold (direct materials only) =

throughput margin



Sales (# units sold @ $8) $620,000 Cost of goods sold (# units sold @ $0.75) 46,500Throughput margin 573,500All other costs:Direct labor 128,000Variable mfg overhead 68,000Fixed mfg overhead 100,000Variable nonmfg overhead costs 55,800Fixed nonmfg costs 70,000Operating income $151,700

Q4: Throughput Costing Income Statement Example

Russell Corporation produces a product that sells for $10. In 2005, there were 10,000 units in beginning finished goods inventory. The company expected to produce, and actually did produce, 80,000 units, and 62,000 units were sold. The costs incurred in 2005 are shown below. Suppose that the Russell Corporation uses the LIFO inventory method. Prepare a throughput costing income statement for 2005.


Note that DL and VO costs expensed based on units produced, not

units sold

Note that DL and VO costs expensed based on units produced, not

units sold

Sales (# units sold @ $8) $620,000 Cost of goods sold (# units sold @ $0.75) 46,500Throughput margin 573,500All other costs:Direct labor 128,000Variable mfg overhead 68,000Fixed mfg overhead 100,000Variable nonmfg overhead costs 55,800Fixed nonmfg costs 70,000Operating income $151,700



Q4: Throughput Costing Income Statement Example continued

Reconcile the income under throughput costing you computed on the prior slide to the income under variable costing computed on slide #13 and to the income under absorption costing computed on slide #4.

Throughput costing income $151,700

Add: Costs attached to the increase in inventory:

Direct labor (18,000 units x $1.60/unit) 28,800

Variable overhead (18,000 units x $0.85/unit) 15,300



(18,000 units x $1.25/unit) 22,500


Throughput costing income $151,700

Add: Costs attached to the increase in inventory:

Direct labor (18,000 units x $1.60/unit) 28,800

Variable overhead (18,000 units x $0.85/unit) 15,300



(18,000 units x $1.25/unit) 22,500




Q5: Uses and Limitations of the Three Income Statement Methods

• Absorption costing is used for external reporting but may not be best for performance evaluation purposes.

• Variable and throughput costing avoid incentives to build up inventory levels.

• Throughput costing may be useful for some short-term decision making.

• Under absorption costing, if practical capacity is used as the denominator level,• the fixed overhead rate is a useful measure of the cost

of capacity, and• the volume variance helps measure the use of capacity.

© John Wiley & Sons, 2005 Chapter 14: Measuring and Assigning Costs for Income Statements Eldenburg...

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