Variable Costing: A Tool for Management 3/17/04 Chapter 7.
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Transcript of Variable Costing: A Tool for Management 3/17/04 Chapter 7.
Variable Costing: A Tool for Management
3/17/04
Chapter 7
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Absorption Costing
Treats all manufacturing costs as product costs, and non-manufacturing costs as period costsUnit costs consist of direct material and direct labor and both variable and fixed manufacturing overhead.Fixed manufacturing overhead is allocated to each unit of productionGAAP
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Variable Costing
Only those costs of manufacturing that vary with output (variable costs) are treated as product costsThis would include direct material, direct labor and variable manufacturing overheadFixed manufacturing overhead is expensed during the current periodVariable costing is used for internal planning and control only; it’s not GAAP!
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Overview of Absorption and Variable(Marginal) Costing
The only cost of driving my caron a 200 mile trip today is
$12 for gasoline.
VariableCosting
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Overview of Absorption and Variable Costing
No! You must consider these costs too!
AbsorptionCosting
Cost Per month Per day
Car payment 300.00$ 10.00$
Insurance 60.00 2.00
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Overview of Absorption and Variable (Marginal) Costing
You are wrong. I have the carpayment and the
insurance payment even ifI do not make the trip.
VariableCosting
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Overview of Absorption and Variable Costing
Who’s right?How should we treat the carpayment and the insurance?
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Marginal Costing
Provides a useful tool for evaluating marginal business propositions
Example, WTT exhibit
Marginal costs versus fixed costs
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Overview of Absorption and 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
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Variable costing
Balance Sheet Costs Inventories
Note: Manufacturing Cost Flows
Income StatementExpenses
Cost of GoodsSold
Fixed Mfr’g OH
Selling andAdministrative
Period Costs
Work in Process
FinishedGoods
Raw Materials
VariableManufacturing
Overhead
Material Purchases
Direct Labor
Selling andAdministrative
FixedManufacturing
Overhead
Absorption costing
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
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. . .
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. . .
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
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. . .
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. . .
Quick Check
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Quick Check
Which method will produce the highest retained earnings? (Hint: Remember the balance sheet equation.)
a. Absorption costing
b. Variable costing
c. There would be no difference in retained earnings under the two methods.
d. It depends ...
Which method will produce the highest retained earnings? (Hint: Remember the balance sheet equation.)
a. Absorption costing
b. Variable costing
c. There would be no difference in retained earnings under the two methods.
d. It depends ...
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Which method will produce the highest retained earnings? (Hint: Remember the balance sheet equation.)
a. Absorption costing, because some fixed costs stay in inventory until the product is sold
b. Variable costing
c. There would be no difference in retained earnings under the two methods.
d. It depends ...
Which method will produce the highest retained earnings? (Hint: Remember the balance sheet equation.)
a. Absorption costing, because some fixed costs stay in inventory until the product is sold
b. Variable costing
c. There would be no difference in retained earnings under the two methods.
d. It depends ...
Quick Check
Assets = Liabilities + Owners’ Equity Assets = Liabilities + Owners’ Equity
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Let’s put some numbers to theissue and see if it will
sharpen our understanding.
Overview of Absorption and Variable Costing
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Harvey Co. produces a single product with the following information available:
Unit Cost Computations
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Unit product cost is determined as follows:
Selling and administrative expenses arealways treated as period expenses and
deducted from revenue.
Unit Cost Computations
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Absorption CostingSales (20,000 × $30) 600,000$ Less cost of goods sold: Beginning inventory -$ Add COGM (25,000 × $16) 400,000 Goods available for sale 400,000 Ending inventory (5,000 × $16) 80,000 320,000 Gross margin 280,000 Less selling & admin. exp. Variable FixedNet operating income
Harvey Co. had no beginning inventory, produced 25,000 units and sold 20,000 units this year.
Income Comparison of Absorption and Variable Costing
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Harvey Co. had no beginning inventory, produced 25,000 units and sold 20,000 units this year.
Absorption CostingSales (20,000 × $30) 600,000$ Less cost of goods sold: Beginning inventory -$ Add COGM (25,000 × $16) 400,000 Goods available for sale 400,000 Ending inventory (5,000 × $16) 80,000 320,000 Gross margin 280,000 Less selling & admin. exp. Variable (20,000 × $3) 60,000$ Fixed 100,000 160,000 Net operating income 120,000$
Income Comparison of Absorption and Variable Costing
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
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$
Now let’s look at variable costing by Harvey Co.Variable
costsonly.
All fixedmanufacturing
overhead isexpensed.
Income Comparison of Absorption and Variable Costing
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Quick Check
The net operating income under absorption costing was $120,000 and under variable costing it was $90,000 because of higher expenses. Where is the missing $30,000 under absorption costing?
a. It has disappeared into an accounting black hole.
b. It is in ending inventories.
c. It represents taxes that have been saved.
d. The $30,000 wasn’t a real cost, so nothing is really missing.
The net operating income under absorption costing was $120,000 and under variable costing it was $90,000 because of higher expenses. Where is the missing $30,000 under absorption costing?
a. It has disappeared into an accounting black hole.
b. It is in ending inventories.
c. It represents taxes that have been saved.
d. The $30,000 wasn’t a real cost, so nothing is really missing.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
The net operating income under absorption costing was $120,000 and under variable costing it was $90,000 because of higher expenses. Where is the missing $30,000 under absorption costing?
a. It has disappeared into an accounting black hole.
b. It is in ending inventories.
c. It represents taxes that have been saved.
d. The $30,000 wasn’t a real cost, so nothing is really missing.
The net operating income under absorption costing was $120,000 and under variable costing it was $90,000 because of higher expenses. Where is the missing $30,000 under absorption costing?
a. It has disappeared into an accounting black hole.
b. It is in ending inventories.
c. It represents taxes that have been saved.
d. The $30,000 wasn’t a real cost, so nothing is really missing.
Quick Check
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Let’s compare the methods.
Income Comparison of Absorption and Variable Costing
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Reconciliation
Variable costing net operating income 90,000$ 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:
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Extending the ExampleLet’s look at the
second yearof operations
for HarveyCompany.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Harvey Co. Year 2
In its second year of operations, Harvey Co. started with an inventory of 5,000 units, produced 25,000
units and sold 30,000 units.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Harvey Co. Year 2
Unit product cost is determined as follows:
No change in Harvey’scost structure.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
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$
Harvey Co. Year 2
These are the 25,000 unitsproduced in the current period.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Harvey Co. Year 2Variable
costsonly.
All fixedmanufacturing
overhead isexpensed.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Reconciliation
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
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Summary
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Comparative Income EffectsExhibit 7-4
Production = SalesNo change in inventory; income the same for both absorption and variable costingProduction > SalesInventories increase; Absorption Income higher than Variable Cost income due to more fixed cost retained in inventoryProduction < SalesInventories decrease; Absorption Income lower than Variable Cost income as more fixed costs are released from inventory
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Advantages of the Variable Cost Approach
Advantages
Management finds it easy to understand.
Consistent withCVP analysis.
Profit is not affected bychanges in inventories.
Can be used for marginal Cost analysis.
Impact of fixedcosts on profitsemphasized.
Easier to estimate profitabilityof products and segments.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
Fixed costs arenot really the costs
of any particularproduct.
VariableCosting
Variable versusAbsorption Costing
AbsorptionCosting
All manufacturingAll manufacturingcosts must be assignedcosts must be assignedto products to properlyto products to properlymatch revenues andmatch revenues and
costs.costs.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
AbsorptionCosting
These are capacitycosts and will be
incurred even if nothingis produced.
Variable versusAbsorption Costing
VariableCosting
Depreciation,taxes, insurance andsalaries are just as
essential to productsas variable costs.
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
VariableCosting
Absorptioncosting product costs
are misleading fordecision making.
They are the numbers that appear on our
external reports.
AbsorptionCosting
Variable versus Absorption costing
© The McGraw-Hill Companies, Inc., 2003McGraw-Hill/Irwin
End of Chapter 7
