Chapter 5 © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill /Irwin Cost Behavior: Analysis and...

Chapter 5Chapter 5

© The McGraw-Hill Companies, Inc., 2007McGraw-Hill /Irwin

Cost Behavior:Analysis and Use

5-2

Learning Objective

LO1LO1

To understand how fixed and variable costs behave and how to use them to predict

costs.

5-3

Summary of Variable and Fixed Cost Behavior

Cost In Total Per Unit

Variable Total variable cost is Variable cost per unit remainsproportional to the activity the same over wide ranges

level within the relevant range. of activity.

Total fixed cost remains thesame even when the activity Fixed cost per unit goes

Fixed level changes within the down as activity level goes up. relevant range.

Recall the summary of our cost behavior Recall the summary of our cost behavior discussion from Chapter 1.discussion from Chapter 1.

Types of Cost Behavior Patterns

5-4

The Activity Base

A measure of what causes the

incurrence of a variable cost

A measure of what causes the

incurrence of a variable cost

UnitsUnitsproducedproduced

UnitsUnitsproducedproduced

Miles driven

Miles driven

Labor hours

Labor hours

Machine hours

Machine hours

5-5

Minutes Talked

To

tal L

on

g D

ista

nce

Tel

eph

on

e B

ill

True Variable Cost ExampleA variable cost is a cost whose total dollar amount

varies in direct proportion to changes in the activity level. Your total long distance telephone

bill is based on how many minutes you talk.

5-6









5-7

Minutes Talked

Per

Min

ute

Tel

eph

on

e C

har

ge

Variable Cost Per Unit Example A variable cost remains constant if expressed

on a per unit basis. The cost per minute talked is constant. For example, 10¢ per minute.

5-8

Extent of Variable Costs

The proportion of variable costs differs across organizations. For example . . .

A public utility withA public utility withlarge investments inlarge investments inequipment will tendequipment will tend

to have to have fewerfewervariable costs.variable costs.

A public utility withA public utility withlarge investments inlarge investments inequipment will tendequipment will tend

to have to have fewerfewervariable costs.variable costs.

A manufacturing companyA manufacturing companywill often have will often have manymany

variable costs.variable costs.

A manufacturing companyA manufacturing companywill often have will often have manymany

variable costs.variable costs.

A merchandising companyA merchandising companyusually will have a usually will have a highhigh

proportionproportion of variable costs of variable costslike cost of sales.like cost of sales.

A merchandising companyA merchandising companyusually will have a usually will have a highhigh

proportionproportion of variable costs of variable costslike cost of sales.like cost of sales.

A service companyA service companywill normally have a will normally have a highhigh

proportionproportion of variable costs. of variable costs.

A service companyA service companywill normally have a will normally have a highhigh

proportionproportion of variable costs. of variable costs.

5-9

Examples of Variable Costs

1.1. Merchandising companiesMerchandising companies – cost of goods sold. – cost of goods sold.

2.2. Manufacturing companiesManufacturing companies – direct materials, – direct materials, direct labor, and variable overhead.direct labor, and variable overhead.

3.3. Merchandising and manufacturing companiesMerchandising and manufacturing companies – – commissions, shipping costs, and clerical costs commissions, shipping costs, and clerical costs such as invoicing.such as invoicing.

4.4. Service companiesService companies – supplies, travel, and – supplies, travel, and clerical.clerical.

1.1. Merchandising companiesMerchandising companies – cost of goods sold. – cost of goods sold.

2.2. Manufacturing companiesManufacturing companies – direct materials, – direct materials, direct labor, and variable overhead.direct labor, and variable overhead.

3.3. Merchandising and manufacturing companiesMerchandising and manufacturing companies – – commissions, shipping costs, and clerical costs commissions, shipping costs, and clerical costs such as invoicing.such as invoicing.

4.4. Service companiesService companies – supplies, travel, and – supplies, travel, and clerical.clerical.

5-10

Volume

Co

st

True Variable Cost

Direct materials is a true or proportionately variable cost because the amount used during

a period will vary in direct proportion to the level of production activity.

5-11

Step-Variable Costs

A resource that is obtainable only in large chunks (such A resource that is obtainable only in large chunks (such as maintenance workers) and whose costs increase or as maintenance workers) and whose costs increase or

decrease only in response to fairly wide changes in decrease only in response to fairly wide changes in activity is known as a activity is known as a step-variable coststep-variable cost..

Volume

Co

st

5-12

Step-Variable Costs

Volume

Co

st

Small changes in the level of production are not likely to have any effect on the number of

maintenance workers employed.

Small changes in the level of production are not likely to have any effect on the number of

maintenance workers employed.

5-13

Step-Variable Costs

Only fairly wide changes in the activity level will cause a change in the number of maintenance

workers employed

Only fairly wide changes in the activity level will cause a change in the number of maintenance

workers employed

Volume

Co

st

5-14

RelevantRange

A straight line closely

approximates a curvilinear

variable cost line within the

relevant range.

A straight line closely

approximates a curvilinear

variable cost line within the

relevant range.

Activity

To

tal

Co

st

Economist’sEconomist’sCurvilinear Cost Curvilinear Cost

FunctionFunction

The Linearity Assumption and the Relevant Range

Accountant’s Straight-Line Accountant’s Straight-Line Approximation (constant Approximation (constant

unit variable cost)unit variable cost)

5-15







Let’s look at fixed cost behavior on the next Let’s look at fixed cost behavior on the next screens.screens.


5-16

Number of Local Calls

Mo

nth

ly B

asic

T

elep

ho

ne

Bill

Total Fixed Cost Example A fixed cost is a cost whose total dollar amount remains A fixed cost is a cost whose total dollar amount remains

constant as the activity level changes. Your monthly constant as the activity level changes. Your monthly basic telephone bill is probably fixed and does not basic telephone bill is probably fixed and does not

change when you make more local calls. change when you make more local calls.

5-17









5-18

Number of Local Calls

Mo

nth

ly B

asic

Tel

eph

on

e B

ill p

er L

oca

l Cal

l

Fixed Cost Per Unit ExampleAverage fixed costs per unit decrease as the activity

level increases. The fixed cost per local call decreases as more local calls are made.

5-19

ExamplesAdvertising and Research and Development

ExamplesAdvertising and Research and Development

ExamplesDepreciation on Buildings and

Equipment and Real Estate Taxes

ExamplesDepreciation on Buildings and

Equipment and Real Estate Taxes

Types of Fixed Costs

DiscretionaryMay be altered in the short-term by current managerial decisions

DiscretionaryMay be altered in the short-term by current managerial decisions

CommittedLong-term, cannot be significantly reduced

in the short-term.

CommittedLong-term, cannot be significantly reduced

in the short-term.

5-20

The Trend Toward Fixed Costs

The trend in many industries is toward greater fixed costs relative to variable costs.

As machines take overAs machines take overmany mundane tasksmany mundane taskspreviously performedpreviously performed

by humans, by humans, ““knowledge workersknowledge workers””

are demanded forare demanded fortheir minds rathertheir minds rather

than their muscles.than their muscles.

As machines take overAs machines take overmany mundane tasksmany mundane taskspreviously performedpreviously performed

by humans, by humans, ““knowledge workersknowledge workers””

are demanded forare demanded fortheir minds rathertheir minds rather

than their muscles.than their muscles.

Knowledge workersKnowledge workerstend to be salaried,tend to be salaried,highly-trained andhighly-trained and

difficult to replace. Thedifficult to replace. Thecost to compensatecost to compensate

these valued employeesthese valued employeesis is relatively fixedrelatively fixed

rather than variable.rather than variable.

Knowledge workersKnowledge workerstend to be salaried,tend to be salaried,highly-trained andhighly-trained and

difficult to replace. Thedifficult to replace. Thecost to compensatecost to compensate

these valued employeesthese valued employeesis is relatively fixedrelatively fixed

rather than variable.rather than variable.

5-21

Is Labor a Variable or a Fixed Cost?

The behavior of wage and salary costs can differ across countries, depending on labor regulations, labor contracts, and custom.

In France, Germany, China, and Japan,management has little flexibility in adjusting

the size of the labor force.Labor costs are more fixed in nature.

In France, Germany, China, and Japan,management has little flexibility in adjusting

the size of the labor force.Labor costs are more fixed in nature.

In the United States and the United Kingdom,management has greater latitude. Labor costs

are more variable in nature.

In the United States and the United Kingdom,management has greater latitude. Labor costs

are more variable in nature.

5-22

Ren

t C

ost

in

T

ho

usa

nd

s o

f D

oll

ars

0 1,000 2,000 3,000 Rented Area (Square Feet)

0

30

60

Fixed Costs and Relevant Range

90

Relevant

Range

Total cost doesn’t change for a wide range of activity,

and then jumps to a new higher cost for

the next higher range of activity.

Total cost doesn’t change for a wide range of activity,

and then jumps to a new higher cost for

the next higher range of activity.

5-23


Example:Example: Office space is Office space is available at a rental rate available at a rental rate of $30,000 per year in of $30,000 per year in increments of 1,000 increments of 1,000 square feet. As the square feet. As the

business grows, more business grows, more space is rented, space is rented,

increasing the total cost.increasing the total cost.

Example:Example: Office space is Office space is available at a rental rate available at a rental rate of $30,000 per year in of $30,000 per year in increments of 1,000 increments of 1,000 square feet. As the square feet. As the

business grows, more business grows, more space is rented, space is rented,

increasing the total cost.increasing the total cost.

The relevant range of activity for a fixed cost is the range of activity over which the graph of

the cost is flat.

5-24

How does this How does this type of fixed cost type of fixed cost differ from a step-differ from a step-

variable cost?variable cost?

Step-variable costs Step-variable costs can be adjusted can be adjusted

more quickly and . . .more quickly and . . .

The width of the The width of the activity steps is activity steps is

much wider for the much wider for the fixed cost.fixed cost.


5-25

Quick Check

Which of the following statements about cost behavior are true?

1. Fixed costs per unit vary with the level of activity.

2. Variable costs per unit are constant within the relevant range.

3. Total fixed costs are constant within the relevant range.

4. Total variable costs are constant within the relevant range.






5-26











Quick Check

5-27

Fixed Monthly

Utility Charge

Variable

Cost per KW

Activity (Kilowatt Hours)

To

tal

Uti

lity

Co

st

X

Y

A mixed cost has both fixed and variablecomponents. Consider your utility costs.

A mixed cost has both fixed and variablecomponents. Consider your utility costs.

Mixed Costs

Total mixed cost

5-28

Fixed Monthly

Utility Charge

Variable

Cost per KW

Activity (Kilowatt Hours)

To

tal

Uti

lity

Co

st

X

Y

Mixed Costs

Total mixed cost

5-29

Mixed Costs Example

If your fixed monthly utility charge is $40, your If your fixed monthly utility charge is $40, your variable cost is $0.03 per kilowatt hour, and your variable cost is $0.03 per kilowatt hour, and your

monthly activity level is 2,000 kilowatt hours, monthly activity level is 2,000 kilowatt hours, what is the amount of your utility bill?what is the amount of your utility bill?

If your fixed monthly utility charge is $40, your If your fixed monthly utility charge is $40, your variable cost is $0.03 per kilowatt hour, and your variable cost is $0.03 per kilowatt hour, and your

monthly activity level is 2,000 kilowatt hours, monthly activity level is 2,000 kilowatt hours, what is the amount of your utility bill?what is the amount of your utility bill?

Y = a + bX

Y = $40 + ($0.03 × 2,000)

Y = $100$100

5-30

Analysis of Mixed Costs

Each account is classified as eitherEach account is classified as eithervariable or fixed based on the analyst’svariable or fixed based on the analyst’s

knowledge of how the account behaves. knowledge of how the account behaves.

Each account is classified as eitherEach account is classified as eithervariable or fixed based on the analyst’svariable or fixed based on the analyst’s

knowledge of how the account behaves. knowledge of how the account behaves.

Cost estimates are based on an Cost estimates are based on an evaluation of production methods, and evaluation of production methods, and

material, labor and overhead material, labor and overhead requirements.requirements.

Cost estimates are based on an Cost estimates are based on an evaluation of production methods, and evaluation of production methods, and

material, labor and overhead material, labor and overhead requirements.requirements.

Account Analysis and the Engineering ApproachAccount Analysis and the Engineering ApproachAccount Analysis and the Engineering ApproachAccount Analysis and the Engineering Approach

5-31

Learning Objective

LO2LO2

To use a scattergraph plotto diagnose cost behavior.

5-32

Plot the data points on a graph Plot the data points on a graph (total cost vs. activity).(total cost vs. activity).

Plot the data points on a graph Plot the data points on a graph (total cost vs. activity).(total cost vs. activity).

0 1 2 3 4

*

Mai

nte

nan

ce C

ost

1,00

0’s

of

Do

llars

10

20

0

***

**

**

*

*

Patient-days in 1,000’s

X

Y

The Scattergraph Method

5-33


Draw a line through the data points with about anDraw a line through the data points with about anequal numbers of points above and below the line. equal numbers of points above and below the line. Draw a line through the data points with about anDraw a line through the data points with about an

equal numbers of points above and below the line. equal numbers of points above and below the line.

0 1 2 3 4

*

Mai

nte

nan

ce C

ost

1,00

0’s

of

Do

llars

10

20

0

***

**

**

*

*


X

Y

5-34


Use one data point to estimate the total level of activity Use one data point to estimate the total level of activity and the total cost. and the total cost.

Use one data point to estimate the total level of activity Use one data point to estimate the total level of activity and the total cost. and the total cost.

Intercept = Fixed cost: $10,000

0 1 2 3 4

*

Mai

nte

nan

ce C

ost

1,00

0’s

of

Do

llars

10

20

0

***

**

**

*

*


X

Y

Patient days = 800Patient days = 800

Total maintenance cost = $11,000Total maintenance cost = $11,000

5-35


Make a quick estimate of variable cost per unit and Make a quick estimate of variable cost per unit and determine the cost equation. determine the cost equation.

Make a quick estimate of variable cost per unit and Make a quick estimate of variable cost per unit and determine the cost equation. determine the cost equation.

Variable cost per unit = $1,000 800

= $1.25/patient-day$1.25/patient-day

Y = $10,000 + $1.25XY = $10,000 + $1.25XY = $10,000 + $1.25XY = $10,000 + $1.25X

Total maintenance at 800 patients 11,000$ Less: Fixed cost 10,000 Estimated total variable cost for 800 patients 1,000$

Total maintenance at 800 patients 11,000$ Less: Fixed cost 10,000 Estimated total variable cost for 800 patients 1,000$

Total maintenance costTotal maintenance costTotal maintenance costTotal maintenance cost Number of patient daysNumber of patient daysNumber of patient daysNumber of patient days

5-36

Learning Objective

LO3LO3

To analyze a mixed cost using the high-low method.

5-37

The High-Low MethodAssume the following hours of maintenance work and the total maintenance costs for six months.

5-38

The High-Low MethodThe The variable cost variable cost

per hourper hour of of maintenance is maintenance is

equal to the change equal to the change in cost divided by in cost divided by

the change in hours.the change in hours.

The The variable cost variable cost per hourper hour of of

maintenance is maintenance is equal to the change equal to the change

in cost divided by in cost divided by the change in hours.the change in hours.

= $8.00/hour$8.00/hour$2,400

300

Hours Total CostHigh 800 9,800$ Low 500 7,400 Change 300 2,400$

5-39

The High-Low Method

Total Fixed Cost = Total Cost – Total Variable CostTotal Fixed Cost = Total Cost – Total Variable Cost

Total Fixed Cost = $9,800 – ($8/hour Total Fixed Cost = $9,800 – ($8/hour × 800 hours)× 800 hours)

Total Fixed Cost = $9,800 – $6,400Total Fixed Cost = $9,800 – $6,400

Total Fixed Cost = Total Fixed Cost = $3,400$3,400

5-40

The High-Low Method

Y = $3,400 + $8.00Y = $3,400 + $8.00XXThe Cost Equation for Maintenance

5-41

Quick Check

Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the variable portion of sales salaries and commission?

a. $0.08 per unit

b. $0.10 per unit

c. $0.12 per unit

d. $0.125 per unit


a. $0.08 per unit

b. $0.10 per unit

c. $0.12 per unit

d. $0.125 per unit

5-42


a. $0.08 per unit

b. $0.10 per unit

c. $0.12 per unit

d. $0.125 per unit


a. $0.08 per unit

b. $0.10 per unit

c. $0.12 per unit

d. $0.125 per unit

Quick Check

$4,000 ÷ 40,000 units = $0.10 per unit

Units Cost

High level 120,000 14,000$

Low level 80,000 10,000

Change 40,000 4,000$

5-43

Quick Check

Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the fixed portion of sales salaries and commissions?

a. $ 2,000

b. $ 4,000

c. $10,000

d. $12,000


a. $ 2,000

b. $ 4,000

c. $10,000

d. $12,000

5-44


a. $ 2,000

b. $ 4,000

c. $10,000

d. $12,000


a. $ 2,000

b. $ 4,000

c. $10,000

d. $12,000

Quick Check

5-45

Least-Squares Regression Method

A method used to analyze mixed costs if a scattergraph plot reveals an approximately linear

relationship between the X and Y variables.

This method uses This method uses allall of the of thedata points to estimatedata points to estimatethe fixed and variablethe fixed and variablecost components of acost components of a

mixed cost.mixed cost.

This method uses This method uses allall of the of thedata points to estimatedata points to estimatethe fixed and variablethe fixed and variablecost components of acost components of a

mixed cost.mixed cost.The goal of this method isThe goal of this method isto fit a straight line to theto fit a straight line to thedata that data that minimizes theminimizes the

sum of the squared errorssum of the squared errors..

The goal of this method isThe goal of this method isto fit a straight line to theto fit a straight line to thedata that data that minimizes theminimizes the

sum of the squared errorssum of the squared errors..

5-46

Least-Squares Regression Method

Software can be used Software can be used to fit a regression line to fit a regression line through the data points.through the data points.

The cost analysis The cost analysis objective is the same: objective is the same: Y = a + bXY = a + bX

The output from the regression analysis can be

used to create an equation that enables you to

estimate total costs at any activity level.

The output from the regression analysis can be

used to create an equation that enables you to

estimate total costs at any activity level.

5-47

Comparing Results From the Three Methods

The three methods just discussed provide The three methods just discussed provide slightly different estimates of the fixed and slightly different estimates of the fixed and

variable cost components of the mixed cost.variable cost components of the mixed cost.

This is to be expected because each method This is to be expected because each method uses different amounts of the data points to uses different amounts of the data points to

provide estimates.provide estimates.

Least-squares regression provides the most Least-squares regression provides the most accurate estimate because it uses all the data accurate estimate because it uses all the data

points.points.

The three methods just discussed provide The three methods just discussed provide slightly different estimates of the fixed and slightly different estimates of the fixed and

variable cost components of the mixed cost.variable cost components of the mixed cost.

This is to be expected because each method This is to be expected because each method uses different amounts of the data points to uses different amounts of the data points to

provide estimates.provide estimates.

Least-squares regression provides the most Least-squares regression provides the most accurate estimate because it uses all the data accurate estimate because it uses all the data

points.points.

5-48

Learning Objective

LO4LO4

To prepare an income statement using the contribution format.

5-49

Let’s put our Let’s put our knowledge of cost knowledge of cost

behavior to work by behavior to work by preparing a preparing a

contribution format contribution format income statement. income statement.

The Contribution Format Income Statement

5-50

The Contribution Format

Total Unit

Sales Revenue 100,000$ 50$

Less: Variable costs 60,000 30

Contribution margin 40,000$ 20$

Less: Fixed costs 30,000

Net operating income 10,000$

Total Unit

Sales Revenue 100,000$ 50$

Less: Variable costs 60,000 30

Contribution margin 40,000$ 20$

Less: Fixed costs 30,000

Net operating income 10,000$

The contribution margin format emphasizes The contribution margin format emphasizes cost behavior. Contribution margin covers fixed cost behavior. Contribution margin covers fixed

costs and provides for income.costs and provides for income.

The contribution margin format emphasizes The contribution margin format emphasizes cost behavior. Contribution margin covers fixed cost behavior. Contribution margin covers fixed

costs and provides for income.costs and provides for income.

5-51

Uses of the Contribution Format

The contribution income statement format is used The contribution income statement format is used as an internal planning and decision making tool. as an internal planning and decision making tool.

We will use this approach for:We will use this approach for:

1.1. Cost-volume-profit analysis (Chapter 6).Cost-volume-profit analysis (Chapter 6).

2.2. Budgeting (Chapter 7).Budgeting (Chapter 7).

3.3. Special decisions such as pricing and make-or-Special decisions such as pricing and make-or-buy analysis (Chapter 11).buy analysis (Chapter 11).

The contribution income statement format is used The contribution income statement format is used as an internal planning and decision making tool. as an internal planning and decision making tool.

We will use this approach for:We will use this approach for:

1.1. Cost-volume-profit analysis (Chapter 6).Cost-volume-profit analysis (Chapter 6).

2.2. Budgeting (Chapter 7).Budgeting (Chapter 7).

3.3. Special decisions such as pricing and make-or-Special decisions such as pricing and make-or-buy analysis (Chapter 11).buy analysis (Chapter 11).

5-52

The Contribution Format

Used primarily forUsed primarily forexternal reporting.external reporting.

Used primarily byUsed primarily bymanagement.management.

5-53

Learning Objective

LO5LO5

To use variable costing to prepare a contribution format

income statement and contrast absorption costing

and variable costing.(Appendix 5A)

5-55

Overview of Absorptionand Variable Costing

Direct Materials

Direct Labor

Variable Manufacturing Overhead

Fixed Manufacturing Overhead

Variable Selling and Administrative Expenses

Fixed Selling and Administrative Expenses

VariableCosting

AbsorptionCosting

ProductCosts

PeriodCosts

ProductCosts

PeriodCosts

5-56

Quick Check

Which method will produce the highest values for work in process and finished goods inventories?

a. Absorption costing.

b. Variable costing.

c. They produce the same values for these inventories.

d. It depends.





d. It depends.

5-57





d. It depends.





d. It depends.

Quick Check

5-58

Unit Cost Computations

Harvey Company produces a single product Harvey Company produces a single product with the following information available:with the following information available:

5-59


Unit Unit product costproduct cost is determined as follows: is determined as follows:

Selling and administrative expenses areSelling and administrative expenses arealways treated asalways treated as period expensesperiod expenses and deducted and deducted

from revenue as incurred.from revenue as incurred.

5-60

Income Comparison ofAbsorption and Variable Costing

Let’s assume the following additional information for Harvey Company. 20,000 units were sold during the year at a price of

$30 each. There were no units in beginning inventory.

Now, let’s compute net operatingincome using both absorptionand variable costing.

5-61

Absorption Costing

5-62

Variable CostingSales (20,000 × $30) 600,000$ Less variable expenses: Beginning inventory -$ Add COGM (25,000 × $10) 250,000 Goods available for sale 250,000 Less ending inventory (5,000 × $10) 50,000 Variable cost of goods sold 200,000 Variable selling & administrative expenses (20,000 × $3) 60,000 260,000 Contribution margin 340,000 Less fixed expenses: Manufacturing overhead 150,000$ Selling & administrative expenses 100,000 250,000 Net operating income 90,000$

Variable CostingSales (20,000 × $30) 600,000$ Less variable expenses: Beginning inventory -$ Add COGM (25,000 × $10) 250,000 Goods available for sale 250,000 Less ending inventory (5,000 × $10) 50,000 Variable cost of goods sold 200,000 Variable selling & administrative expenses (20,000 × $3) 60,000 260,000 Contribution margin 340,000 Less fixed expenses: Manufacturing overhead 150,000$ Selling & administrative expenses 100,000 250,000 Net operating income 90,000$

Variablemanufacturing

costs only.

All fixedmanufacturing

overhead isexpensed.

Variable Costing

5-63

Income Comparison ofAbsorption and Variable Costing

Let’s compare the methods.

5-64

Comparing the Two Methods

Variable costing net operating income 90,000$ Add: Fixed mfg. overhead costs deferred in inventory (5,000 units × $6 per unit) 30,000 Absorption costing net operating income 120,000$

Variable costing net operating income 90,000$ Add: Fixed mfg. overhead costs deferred in inventory (5,000 units × $6 per unit) 30,000 Absorption costing net operating income 120,000$

Fixed mfg. Overhead $150,000 Units produced 25,000 units

= = $6.00 per unit

We can reconcile the difference betweenabsorption and variable income as follows:

5-65

Extended Comparison of Income DataHere is information about the operation of Harvey Company

for the second year.

5-66


Since there was no change in the variable costsSince there was no change in the variable costsper unit, total fixed costs, or the number ofper unit, total fixed costs, or the number of

units produced, the unit costs remain unchanged.units produced, the unit costs remain unchanged.

Since there was no change in the variable costsSince there was no change in the variable costsper unit, total fixed costs, or the number ofper unit, total fixed costs, or the number of

units produced, the unit costs remain unchanged.units produced, the unit costs remain unchanged.

5-67

Absorption CostingSales (30,000 × $30) 900,000$ Less cost of goods sold: Beg. inventory (5,000 × $16) 80,000$ Add COGM (25,000 × $16) 400,000 Goods available for sale 480,000 Less ending inventory - 480,000 Gross margin 420,000 Less selling & admin. exp. Variable (30,000 × $3) 90,000$ Fixed 100,000 190,000 Net operating income 230,000$

Absorption CostingSales (30,000 × $30) 900,000$ Less cost of goods sold: Beg. inventory (5,000 × $16) 80,000$ Add COGM (25,000 × $16) 400,000 Goods available for sale 480,000 Less ending inventory - 480,000 Gross margin 420,000 Less selling & admin. exp. Variable (30,000 × $3) 90,000$ Fixed 100,000 190,000 Net operating income 230,000$

Absorption Costing

These are the 25,000 unitsThese are the 25,000 unitsproduced in the current period.produced in the current period.

These are the 25,000 unitsThese are the 25,000 unitsproduced in the current period.produced in the current period.

5-68

Variable Costing

All fixedAll fixedmanufacturingmanufacturing

overhead isoverhead isexpensed.expensed.

VariableVariablemanufacturing manufacturing

costs only.costs only.

5-69

Comparing the Two Methods

Variable costing net operating income 260,000$ Deduct: Fixed manufacturing overhead costs released from inventory (5,000 units × $6 per unit) 30,000 Absorption costing net operating income 230,000$

We can reconcile the difference betweenabsorption and variable income as follows:

Fixed mfg. Overhead $150,000 Units produced 25,000 units

= = $6.00 per unit

5-70

Income Comparison

5-71

Summary of Key Insights

5-72

End of Chapter 5

Chapter 5 © The McGraw-Hill Companies, Inc., 2007 McGraw-Hill /Irwin Cost Behavior: Analysis and...

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