Manerial accounting 11e garrison noreen brewer chap007

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11th Edition Chapter McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Variable Costing: A Tool for Management Chapter Seven McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Overview of Absorption and Variable Costing Absorption Costing Variable Costing Direct Materials Product Costs Product Costs Direct Labor Variable Manufacturing Overhead Fixed Manufacturing Overhead Period Costs McGraw-Hill/Irwin Variable Selling and Administrative Expenses Period Costs Fixed Selling and Administrative Expenses Copyright © 2006, The McGraw-Hill Companies, Inc Quick Check  Which Which method method will will produce produce the the highest highest values values for for work work in in process process and and finished finished goods goods inventories? inventories? a a Absorption Absorption costing costing b b Variable Variable costing costing c c They They produce produce the the same same values values for for these these inventories inventories d d ItIt depends depends McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Quick Check  Which Which method method will will produce produce the the highest highest values values for for work work in in process process and and finished finished goods goods inventories? inventories? a a Absorption Absorption costing costing b b Variable Variable costing costing c c They They produce produce the the same same values values for for these these inventories inventories d d ItIt depends depends McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Unit Cost Computations Harvey Company produces a single product with the following information available: Number of units produced annually Variable costs per unit: Direct materials, direct labor, and variable mfg overhead Selling & administrative expenses $ $ Fixed costs per year: Manufacturing overhead Selling & administrative expenses $ 150,000 $ 100,000 McGraw-Hill/Irwin 25,000 10 Copyright © 2006, The McGraw-Hill Companies, Inc Unit Cost Computations Unit product cost is determined as follows: Direct materials, direct labor, and variable mfg overhead Fixed mfg overhead ($150,000 ÷ 25,000 units) Unit product cost Absorption Costing Variable Costing $ 10 $ 10 $ 16 $ 10 Selling and administrative expenses are always treated as period expenses and deducted from revenue as incurred McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Income Comparison of Absorption 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 operating income using both absorption and variable costing McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Absorption Costing Absorption Costing Sales (20,000 × $30) 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 Gross margin Less selling & admin exp Variable (20,000 × $3) $ 60,000 Fixed 100,000 Net operating income McGraw-Hill/Irwin $ 600,000 320,000 280,000 160,000 $ 120,000 Copyright © 2006, The McGraw-Hill Companies, Inc Variable Costing Variable manufacturing Variable Costing costs only Sales (20,000 × $30) 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 Contribution margin Less fixed expenses: Manufacturing overhead $ 150,000 Selling & administrative expenses 100,000 Net operating income McGraw-Hill/Irwin $ 600,000 All fixed manufacturing overhead is expensed 260,000 340,000 250,000 $ 90,000 Copyright © 2006, The McGraw-Hill Companies, Inc Absorption Costing: Year One Absorption Costing Sales (25,000 × $30) Less cost of goods sold: Beginning inventory $ Add COGM (30,000 × $15) 450,000 Goods available for sale 450,000 Ending inventory (5,000 × $15) 75,000 Gross margin Less selling & admin exp Variable (25,000 × $3) $ 75,000 Fixed 100,000 Net operating income McGraw-Hill/Irwin $ 750,000 375,000 375,000 175,000 $ 200,000 Copyright © 2006, The McGraw-Hill Companies, Inc Variable Costing: Year One Variable manufacturing Variable Costing costs only Sales (25,000 × $30) Less variable expenses: Beginning inventory $ Add COGM (30,000 × $10) 300,000 Goods available for sale 300,000 Less ending inventory (5,000 × $10) 50,000 Variable cost of goods sold 250,000 Variable selling & administrative expenses (25,000 × $3) 75,000 Contribution margin Less fixed expenses: Manufacturing overhead $ 150,000 Selling & administrative expenses 100,000 Net operating income McGraw-Hill/Irwin $ 750,000 All fixed manufacturing overhead is expensed 325,000 425,000 250,000 $ 175,000 Copyright © 2006, The McGraw-Hill Companies, Inc Effect of Changes in Production Harvey Company Year Two Number of units produced Number of units sold Units in beginning inventory Unit sales price Variable costs per unit: Direct materials, direct labor variable mfg overhead Selling & administrative expenses Fixed costs per year: Manufacturing overhead Selling & administrative expenses McGraw-Hill/Irwin 20,000 25,000 5,000 $ 30 $ 10 $ $ 150,000 $ 100,000 Copyright © 2006, The McGraw-Hill Companies, Inc Unit Cost Computations for Year Two Unit product cost is determined as follows: Direct materials, direct labor, and variable mfg overhead Fixed mfg overhead ($150,000 ÷ 20,000 units) Unit product cost Absorption Costing Variable Costing $ 10 $ 10 $ 7.50 17.50 $ 10 Since Since the the number number of of units units produced produced decreased decreased in in the the second second year, year, while while the the fixed fixed manufacturing manufacturing overhead overhead remained remained the the same, same, the the absorption absorption unit unit cost cost is is now now higher higher McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Absorption Costing: Year Two Absorption Costing Sales (25,000 × $30) Less cost of goods sold: Beg inventory (5,000 × $15) Add COGM (20,000 × $17.50) Goods available for sale Less ending inventory Gross margin Less selling & admin exp Variable (25,000 × $3) Fixed Net operating income $ 750,000 $ 75,000 350,000 425,000 - $ 75,000 100,000 425,000 325,000 175,000 $ 150,000 These are the 20,000 units produced in the current period at the higher unit cost of $17.50 each McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Variable Costing: Year Two Variable manufacturing costs only Variable Costing Sales (25,000 × $30) $ 750,000 Less variable expenses: Beg inventory (5,000 × $10) $ 50,000 Add COGM (20,000 × $10) 200,000 All fixed Goods available for sale 250,000 manufacturing Less ending inventory overhead is Variable cost of goods sold 250,000 expensed Variable selling & administrative expenses (25,000 × $3) 75,000 325,000 Contribution margin 425,000 Less fixed expenses: Manufacturing overhead $ 150,000 Selling & administrative expenses 100,000 250,000 Net operating income $ 175,000 McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Income Comparison Costing Method Absorption Variable Year One $ 200,000 175,000 Year Two $ 150,000 175,000 Total $ 350,000 350,000 Conclusions  Net operating income is not affected by changes in production using variable costing  Net operating income is affected by changes in production using absorption costing even though the number of units sold is the same each year McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Impact on the Manager Opponents Opponentsof of absorption absorptioncosting costingargue arguethat thatshifting shifting fixed fixedmanufacturing manufacturingoverhead overheadcosts costsbetween betweenperiods periods can canlead leadto tomisinterpretations misinterpretationsand andfaulty faultydecisions decisions Those Thosewho whofavor favorvariable variablecosting costingargue arguethat thatthe theincome income statements statementsare areeasier easierto tounderstand understandbecause becausenet netoperating operating income incomeisisonly onlyaffected affectedby bychanges changesin inunit unit sales sales The The resulting resultingincome incomeamounts amountsare aremore moreconsistent consistentwith with managers’ managers’expectations expectations McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc CVP Analysis, Decision Making and Absorption costing Absorption costing does not support CVP analysis because it essentially treats fixed manufacturing overhead as a variable cost by assigning a per unit amount of the fixed overhead to each unit of production Treating Treatingfixed fixedmanufacturing manufacturingoverhead overheadas asaa variable variablecost cost can: can: •• Lead Leadto tofaulty faultypricing pricingdecisions decisionsand andkeep/drop keep/drop decisions decisions •• Produce Producepositive positivenet net operating operatingincome income even even when whenthe thenumber number of ofunits unitssold soldisisless less than thanthe the breakeven breakevenpoint point McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc External Reporting and Income Taxes To Toconform conformto to GAAP GAAPrequirements, requirements, absorption absorptioncosting costingmust mustbe beused usedfor for external externalfinancial financialreports reportsin inthe the United UnitedStates States Under Under the theTax Tax Reform Reform Act Act of of 1986, 1986, absorption absorptioncosting costingmust mustbe be used when filing income used when filing income Since Sincetop topexecutives executives tax taxreturns returns are usually evaluated based on are usually evaluated based on external externalreports reportsto toshareholders, shareholders, they theymay mayfeel feel that that decisions decisions should shouldbe bebased basedon on absorption absorptioncost costincome income McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Advantages of Variable Costing and the Contribution Approach Management finds it more useful Advantages Impact of fixed costs on profits emphasized McGraw-Hill/Irwin Consistent with CVP analysis Net operating income is closer to net cash flow Consistent with standard costs and flexible budgeting Easier to estimate profitability of products and segments Profit is not affected by changes in inventories Copyright © 2006, The McGraw-Hill Companies, Inc Variable versus Absorption Costing Fixed manufacturing costs must be assigned to products to properly match revenues and costs Absorption Costing McGraw-Hill/Irwin Fixed manufacturing costs are capacity costs and will be incurred even if nothing is produced Variable Costing Copyright © 2006, The McGraw-Hill Companies, Inc Variable Costing and the Theory of Constraints (TOC) Companies Companies involved involved in in TOC TOC use use aa form form of of variable variable costing, costing, but but treating treating direct direct labor labor as as aa fixed fixed cost cost for for three three reasons: reasons:   Many Many companies companies have have aa commitment commitment to to guarantee guarantee workers workers aa minimum minimum number number of of paid paid hours hours   TOC TOC emphasizes emphasizes the the role role of of direct direct labor labor in in continuous continuous improvement improvement Fluctuating Fluctuating levels levels of of direct direct labor labor can can devastate devastate morale morale and and defeat defeat the the role role of of employees employees in in continuous continuous improvement improvement efforts efforts   Direct Direct labor labor isis usually usually not not the the constraint constraint McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc Impact of JIT Inventory Methods In a JIT inventory system Production tends to equal sales So, the difference between variable and absorption income tends to disappear McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc End of Chapter McGraw-Hill/Irwin Copyright © 2006, The McGraw-Hill Companies, Inc
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