Managerial Accountingby James Jiambalvo

Chapter 5:

Variable Costing

Slides Prepared by:

Scott Peterson

Northern State University

Objectives

1. Explain the difference between full (absorption) and variable costing.

2. Prepare an income statement using variable costing.

3. Discuss the effect of production on full and variable costing income.

4. Explain the impact of JIT (just-in-time) on the difference between full and variable costing income.

5. Discuss the benefits of variable costing for internal reporting purposes

Full (Absorption) Costing

1. Full (Absorption) Costing includes:a. Direct materialb. Direct laborc. Manufacturing overhead (both

variable and fixed)2. Decision making and “what-if”

decisions are difficult because of the commingling of fixed and variable overhead.

3. Required for GAAP.

Variable Costing

1. Variable Costing includes:

a. Direct material

b. Direct labor

c. Variable Manufacturing overhead

2. Variable Costing lends itself well to decision making and “what-if” analyses.

3. Not allowed for GAAP.

Differences Between Full (Absorption) and Variable Costing

1. Fixed manufacturing overhead (included in Full Costing).

2. Fixed manufacturing costs, like depreciation, are a period expense on the income statement under variable costing.

3. Fixed manufacturing costs, like depreciation, are inventoried until sold under full costing.

Variable Costing Income Statement

1. The format uses a contribution margin approach.

2. All costs, manufacturing, selling and administrative, are classified as either fixed or variable.

Variable Costing Income Statement Example

Sales$100,000

Less Variable:Variable COGS $20,000Variable Selling 10,000Variable Admin. 5,000 35,000

Contribution Margin 65,000Less Fixed:

Fixed Mfg. 10,000Fixed Selling 8,000Fixed Admin 7,000 25,000

Net Income 40,000

Full (Absorption) Costing Income Statement Example

Sales$100,000

Less COGS 30,000Gross Margin 70,000Less Selling and Admin:

Selling 18,000Admin 12,000 30,000

Net Income 40,000

Effects of Production on Income for Full Versus Variable Costing: Clausen Tube

Facts: 5,000 units produced and sold Selling Price: $2,000 per unit Variable Manufacturing:

Direct Materials: $600 per unit Direct Labor: $225 per unit Variable MFG: $75 per unit

Fixed Manufacturing: $1,200,000 per year Selling Expense: $40 per unit variable plus

$100,000 fixed. Administrative: $500,000 per year (fixed)

Clausen Tube Income Statement: Full Costing

Sales $10,000,000Less COGS 5,700,000Gross Margin 4,300,000Less Selling and Admin:

Selling $300,000Admin 500,000 800,000

Net Income $3,500,000

Clausen Tube Income Statement: Variable Costing

Sales $10,000,000Less Variable:Variable COGS $4,500,000Variable Selling

and Admin 200,000Contribution Margin 5,300,000Less Fixed:

Fixed Mfg. 1,200,000Fixed Selling 100,000Fixed Admin 500,000 1,800,000

Net Income $3,500,000

Variable Costing Income Statement: Considerations

1. When sales volume and production volume are exactly equal, net income is the same under either full or variable costing.

2. Contribution margin is easily calculated under variable costing: 2,000 – 940 = 1,060.

3. Contribution margin ratio is: 1,060 / 2,000 = 53%

Clausen Tube: Production is Greater Than Sales

Facts: 6,000 units produced and 4,800 units sold Selling Price: $2,000 per unit Variable Manufacturing:

Direct Materials: $600 per unit Direct Labor: $225 per unit Variable MFG: $75 per unit

Fixed Manufacturing: $1,200,000 per year Selling Expense: $40 per unit variable plus

$100,000 fixed. Administrative: $500,000 per year (fixed)

Clausen Tube Income Statement: Full Costing-- Production > Sales

Sales $ 9,600,000Less COGS 5,280,000Gross Margin 4,320,000Less Selling and Admin:

Selling $292,200Admin 500,000 792,200

Net Income $3,528,000

Clausen Tube Income Statement: Variable Costing-- Production > Sales

Sales $ 9,600,000Less Variable:Variable COGS $4,320,000Variable Selling

and Admin 192,000Contribution Margin 5,088,000Less Fixed:

Fixed Mfg. 1,200,000Fixed Selling 100,000Fixed Admin 500,000 1,800,000

Net Income $3,288,000

Variable Costing Income Statement: Considerations-- Production > Sales

1. Net income is higher under full costing than variable costing.

2. $3,528,000 vs. $3,288,000 = $240,0003. The $240,000 difference is due to the

1,200 (6,000 – 4,800) additional units produced and unsold.

4. Fixed manufacturing $1,200,000 / 6,000 units x 1,200 units remaining = $240,000

Summary of Effects of Production on Net Income

If units produced = units sold, then no difference between full costing and variable costing net income.

If units produced > units sold, then full costing net income is greater than variable costing net income.

If units produced < units sold, then full costing net income is less than variable costing net income.

Impact of JIT on the Income Effects of Full Versus Variable Costing

1. JIT (Just-In-Time) inventory systems lead to low inventories.

2. Results in little difference between production and sales.

3. Variable versus absorption net income differences negligible.

Benefits of Variable Costing for Internal Reporting

1. Variable costing facilitates C-V-P analysis because it uses a “contribution” approach.

2. Variable costing mitigates the effects of earnings management because fixed manufacturing costs are not inventoried. Thus, merely increasing production volume relative to sales will not boost net income.

Quick Review Question #1

1. Which of the following lends itself well to C-V-P Analysis?

a. Full Costing

b. Absorption Costing

c. Variable Costing

d. Average Costing

Quick Review Answer #1

1. Which of the following lends itself well to C-V-P Analysis?

a. Full Costing

b. Absorption Costing

c. Variable Costing

d. Average Costing

Quick Review Question #2

2. Units produced = 2,000, units sold = 1,800, contribution margin ratio is 37%, fixed S & A expenses are $90,000. Fixed mfg. Expenses are $80,200 By how much is net income greater under full costing than variable costing?a. $8,020b. $80,200c. $9,000d. $17,020

Quick Review Answer #2

2. Units produced = 2,000, units sold = 1,800, contribution margin ratio is 37%, fixed S & A expenses are $90,000. Fixed mfg. Expenses are $80,200 By how much is net income greater under full costing than variable costing?a. $8,020b. $80,200c. $9,000d. $17,020

Quick Review Question #3

3. Which of the following complies with GAAP for external reporting purposes?

a. Absolute costing

b. Variable costing

c. Fixed costing

d. Absorption costing

Quick Review Answer #3

3. Which of the following complies with GAAP for external reporting purposes?

a. Absolute costing

b. Variable costing

c. Fixed costing

d. Absorption costing

Quick Review Question #4

4. Which of the following lends itself well to internal decision making?

a. Full costing

b. Variable costing

c. Absorption costing

d. None of these

Quick Review Answer #4

4. Which of the following lends itself well to internal decision making?

a. Full costing

b. Variable costing

c. Absorption costing

d. None of these

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