Upload
karen-villafuerte
View
240
Download
3
Embed Size (px)
Citation preview
7/30/2019 Absorption & Variable Costing
1/40
Absorption & Variable CostingGroup One
7/30/2019 Absorption & Variable Costing
2/40
1. Explain how vaiable costing differs fromabsorption costin and compute unit productcosts under each method
2. Prepare income statement using both variableand absorption costing.3. Reconcile variable costing and absorption
costing net operating incomes and explainwhy the two amounts differ.
4. Understand the advantages anddisadvantages of both variable andabsorption costing.
Objectives
After studying thischapter, you should
be able to:
7/30/2019 Absorption & Variable Costing
3/40
Review: Product vs Period Cost Product Cost
Traced directly to the product Denim for jeans, labor to sew the pants.. Direct
Materials, Direct Labor
Period Cost Costs incurred with the passage of time Interest on loan, insurance premiums coverage
7/30/2019 Absorption & Variable Costing
4/40
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
7/30/2019 Absorption & Variable Costing
5/40
Two Costing Methods
Used for external financialreporting
Includes direct materials, directlabor, variable factory overhead,
and fixed factory overhead aspart of total product cost
Absorption Costing
7/30/2019 Absorption & Variable Costing
6/40
Two Costing Methods
Variable Costing
Used for internal planningand decision making
Does not include fixed factoryoverhead as a product cost
7/30/2019 Absorption & Variable Costing
7/40
Selling and Administrative Never treated as product cost Variable and fixed selling and
administrative expenses are treatedperiod costs and expensed are
incurred
7/30/2019 Absorption & Variable Costing
8/40
Summary of Differences
7/30/2019 Absorption & Variable Costing
9/40
Absorption Costing Compared toVariable Costing
Variable Costing
Absorption Costing
Cost of Goods Manufactured
Cost of Goods Manufactured
DirectMaterials
DirectLabor
VariableFactory OH
FixedFactory OH
Period Expense
7/30/2019 Absorption & Variable Costing
10/40
Unit Cost Computations
7/30/2019 Absorption & Variable Costing
11/40
Unit Cost Computations
Selling and administrative expenses arealways treated as period expenses and deducted from revenue as incurred.
7/30/2019 Absorption & Variable Costing
12/40
Income Comparison of Absorptionand Variable Costing
Lets assume the following additional information for HarveyCompany. 20,000 units were sold during the year at a price of $30 each. There were no units in beginning inventory.
Now, lets compute net operatingincome using both absorptionand variable costing.
7/30/2019 Absorption & Variable Costing
13/40
Absorption Costing
7/30/2019 Absorption & Variable Costing
14/40
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$
Variablemanufacturingcosts only.
All fixedmanufacturing
overhead isexpensed.
Variable Costing
7/30/2019 Absorption & Variable Costing
15/40
Income Comparison of Absorption and Variable CostingLets compare the methods.
7/30/2019 Absorption & Variable Costing
16/40
Reconciliation
Variable costing net operating income 90,000$Add: Fixed mfg. overhead costsdeferred in inventory(5,000 units $6 per unit) 30,000
Absorption costing net operating income 120,000$
Fixed mfg. Overhead $150,000Units produced 25,000 units= = $6.00 per unit
We can reconcile the difference betweenabsorption and variable income as follows:
7/30/2019 Absorption & Variable Costing
17/40
Extended Comparison of Income DataHarvey Company Year Two
7/30/2019 Absorption & Variable Costing
18/40
Unit Cost Computations
Since there was no change in the variable costsper unit, total fixed costs, or the number of
units produced, the unit costs remain unchanged.
7/30/2019 Absorption & Variable Costing
19/40
7/30/2019 Absorption & Variable Costing
20/40
Variable Costing
All fixedmanufacturingoverhead isexpensed.
Variablemanufacturing
costs only.
7/30/2019 Absorption & Variable Costing
21/40
Reconciliation
Variable costing net operating income 260,000$Deduct: Fixed manufacturing overheadcosts 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 $150,000Units produced 25,000 units= = $6.00 per unit
7/30/2019 Absorption & Variable Costing
22/40
Income Comparison
7/30/2019 Absorption & Variable Costing
23/40
7/30/2019 Absorption & Variable Costing
24/40
Effect of Changes in Productionon Net Operating Income
In the previous example,25,000 units were produced each year,
but sales increased from 20,000 units in year one to 30,000 units in year two.
In this revised example,production will differ each year while
sales will remain constant.
Lets revise the Harvey Company example.
7/30/2019 Absorption & Variable Costing
25/40
Effect of Changes in ProductionHarvey Company Year One
7/30/2019 Absorption & Variable Costing
26/40
Unit Cost Computations for Year One
Since the number of units produced increasedin this example, while the fixed manufacturing overhead
remained the same, the absorption unit cost is less.
7/30/2019 Absorption & Variable Costing
27/40
Absorption Costing: Year One
7/30/2019 Absorption & Variable Costing
28/40
Variable CostingSales (25,000 $30) 750,000$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 $3) 75,000 325,000 Contribution margin 425,000 Less fixed expenses:
Manufacturing overhead 150,000$Selling & administrative expenses 100,000 250,000
Net operating income 175,000$
Variable Costing: Year OneVariablemanufacturing
costs only.
All fixedmanufacturing
overhead isexpensed.
7/30/2019 Absorption & Variable Costing
29/40
Effect of Changes in ProductionHarvey Company Year Two
7/30/2019 Absorption & Variable Costing
30/40
7/30/2019 Absorption & Variable Costing
31/40
Absorption CostingSales (25,000 $30) 750,000$Less cost of goods sold:
Beg. inventory (5,000 $15 ) 75,000$
Add COGM (20,000 $17.50 ) 350,000 Goods available for sale 425,000 Less ending inventory - 425,000
Gross margin 325,000 Less selling & admin. exp.
Variable (25,000 $3) 75,000$Fixed 100,000 175,000
Net operating income 150,000$
Absorption Costing: Year Two
These are the 20,000 units produced in the current
period at the higher unit cost of $17.50 each.
7/30/2019 Absorption & Variable Costing
32/40
Variable Costing: Year Two
All fixedmanufacturing
overhead isexpensed.
Variablemanufacturing
costs only.
7/30/2019 Absorption & Variable Costing
33/40
Income Comparison
Net operating income is not affected by changes inproduction using variable costing.
Net operating income is affected by changes in productionusing absorption costing even though the number of units
sold is the same each year.
Conclusions
7/30/2019 Absorption & Variable Costing
34/40
Impact on the ManagerOpponents of absorption costing argue that shiftingfixed manufacturing overhead costs between periodscan lead to misinterpretations and faulty decisions.
Those who favor variable costing argue that the incomestatements are easier to understand because net operatingincome is only affected by changes in unit sales. The
resulting income amounts are more consistent withmanagers expectations.
7/30/2019 Absorption & Variable Costing
35/40
CVP Analysis, Decision Makingand Absorption costing
Absorption costing does not support CVP analysis because itessentially treats fixed manufacturing overhead as a
variable cost by assigning a per unit amount of the fixedoverhead to each unit of production.
Treating fixed manufacturing overhead as avariable cost can:
Lead to faulty pricing decisions and keep/dropdecisions.
Produce positive net operating income evenwhen the number of units sold is less than the
breakeven point.
7/30/2019 Absorption & Variable Costing
36/40
External Reporting and Income TaxesTo conform to
GAAP requirements,absorption costing must be used for
external financial reports in theUnited States. Under the Tax
Reform Act of 1986,absorption costing must be
used when filing incometax returns.
Since top executives
are usually evaluated based onexternal reports to shareholders,
they may feel that decisionsshould be based on
absorption cost income.
7/30/2019 Absorption & Variable Costing
37/40
Advantages of Variable Costingand the Contribution Approach
Advantages
Management findsit more useful.
Consistent withCVP analysis.Net operating income
is closer tonet cash flow.
Profit is not affected by
changes in inventories.
Consistent with standardcosts and flexible budgeting.
Impact of fixedcosts on profits
emphasized.
Easier to estimate profitabilityof products and segments.
7/30/2019 Absorption & Variable Costing
38/40
VariableCosting
Variable versus AbsorptionCosting
AbsorptionCosting
Fixed manufacturingcosts must be assignedto products to properlymatch revenues and
costs.
Fixed manufacturingcosts are capacity costs
and will be incurredeven if nothing is
produced.
7/30/2019 Absorption & Variable Costing
39/40
7/30/2019 Absorption & Variable Costing
40/40
Impact of JIT InventoryMethodsIn a JIT inventory system . . .
Productiontends to equal
sales . . .
So, the difference between variable andabsorption income tends to disappear.