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Chapter 5 Variable Costing
Contains Fixed Manufacturing
Overhead
Presentation Outline
I. Absorption Costing v. Variable Costing
II. A Comparison of Income Data for Absorption Costing and Variable
CostingIII. An Illustration
I. Absorption Costing v. Variable Costing
A. Cost ClassificationsB. Fixed Manufacturing OverheadC. Format of Income StatementD. Report Usage
A. Cost ClassificationsAbsorption Costing Variable Costing
Product costs include:
> Direct materials
> Direct labor
> Variable mfg. overhead
> Fixed mfg. overhead
Product costs include:
> Direct materials
> Direct labor
> Variable mfg. overhead
Period costs include:
> Selling & admin. expenses
Period costs include:
> Selling & admin. expenses
> Fixed mfg. overhead
B. Fixed Manufacturing OverheadAbsorption Costing Variable Costing
Fixed manufacturing overhead is treated as a product cost.
Fixed manufacturing overhead is treated as a period cost and
deducted in full each year from revenues.
Balance Sheet
Fixed mfg. overheadFixed mfg. overhead is
never an asset.
C. Format of Income StatementFull (Absorption) Costing Variable Costing
Sales
- Cost of goods sold
= Gross margin
- Selling & admin. expenses
= Net income
Sales
- Variable expenses
= Contribution margin
- Fixed expenses
= Net income
See Illustration 5-2 on page 166.
D. Report Usage
Absorption costing is required for external reporting.
Variable costing is permitted for internal use only.
II. A Comparison of Income Data for Absorption Costing and
Variable Costing
A. Production = Sales (no change in inventories)
B. Production > Sales (inventories increase)
C. Production < Sales (inventories decrease)
A. Production = Sales (No change in inventories)
Absorption Costing Net Income
Variable Costing Net Income
If there is no change in inventories, then there is generally no change in the fixed manufacturing
overhead costs in inventories under absorption costing.
B. Production > Sales (Inventories increase)
Absorption Costing Net Income
Variable Costing Net Income
If inventories increase, then some of the current fixed manufacturing overhead costs will be deferred in
inventories under absorption costing.
C. Production < Sales (Inventories decrease)
Absorption Costing Net Income
Variable Costing Net Income
If inventories decrease, then some of the prior fixed manufacturing overhead costs that had been deferred
in inventories under absorption costing, will be released as a current charge against income.
III. An Illustration
Selling price per unit $2,000
Variable costs per unit:
Direct materials $ 600
Direct labor $ 225
Variable manufacturing overhead $ 75
Variable selling and administrative expenses $ 40
Fixed costs per year:
Fixed manufacturing overhead $1,200,000
Fixed selling expenses $ 100,000
Fixed administrative expenses $ 500,000
Annual production in units 5,000
Compute the unit product cost under absorption costing.
Direct materials 600
Direct labor 225
Variable manufacturing overhead 75
Fixed manufacturing overhead ($1,200,000 / 5,000 units) 240
Absorption unit product cost 1,140
Compute the unit product cost under variable costing.
Direct materials 600
Direct labor 225
Variable manufacturing overhead 75
Variable unit product cost 900
Year 1 Assumption:Production = Sales
5,000 units = 5,000 units
Variable Costing Income Statement
Sales (5,000 units x $2,000) 10,000,000
Less variable expenses
Cost of goods sold:
Beginning finished goods inventory 0
Cost of goods mfg (5,000 units x $900) 4,500,000
Goods available for sale 4,500,000
Ending fin. goods inventory 0
Cost of goods sold 4,500,000
Selling expense (5,000 units x $40) 200,000
Contribution margin 5,300,000
Less fixed expenses:
Manufacturing overhead 1,200,000
Selling expense 100,000
Administrative expense 500,000
Net income 3,500,000
Abosorption Costing Income Statement
Sales (5,000 units x $2,000) 10,000,000
Less cost of goods sold:
Beginning finished goods inventory 0
Cost of goods mfg (5,000 units x $1,140) 5,700,000
Goods available for sale 5,700,000
Ending fin. goods inventory 0
Cost of goods sold 5,700,000
Gross margin 4,300,000
Operating expenses:
Selling expenses ($100,000 + (5,000 units x $40) 300,000
Administrative expenses 500,000
Net operating income 3,500,000
Year 2 Assumption:Production > Sales
5,000 units = 4,800 units
Variable Costing Income Statement
Sales (4,800 units x $2,000) 9,600,000
Less variable expenses
Cost of goods sold:
Beginning finished goods inventory 0
Cost of goods mfg (5,000 units x $900) 4,500,000
Goods available for sale 4,500,000
Ending fin. goods inventory (200 units x $900) 180,000
Cost of goods sold 4,320,000
Selling expense (4,800 units x $40) 192,000
Contribution margin 5,088,000
Less fixed expenses:
Manufacturing overhead 1,200,000
Selling expense 100,000
Administrative expense 500,000
Net income 3,288,000
Abosorption Costing Income Statement
Sales (4,800 units x $2,000) 9,600,000
Less cost of goods sold:
Beginning finished goods inventory 0
Cost of goods mfg (5,000 units x $1,140) 5,700,000
Goods available for sale 5,700,000
End. fin. goods inv. (200 units x $1,140) 228,000
Cost of goods sold 5,472,000
Gross margin 4,128,000
Operating expenses:
Selling expenses ($100,000 + (4,800 units x $40) 292,000
Administrative expenses 500,000
Net operating income 3,336,000
Reconciliation of the operating income between variable costing and absorptioncosting
Variable costing net income 3,288,000
- Fixed manufacturing overhead released from
beginning inventory
0 units x $240 0
+ Fixed manufacturing overhead deferred in
ending inventory
200 units x $240 48,000
Absorption costing net income 3,336,000
Year 3 Assumption:Production < Sales
5,000 units = 5,200 units
Variable Costing Income Statement
Sales (5,200 units x $2,000) 10,400,000
Less variable expenses
Cost of goods sold:
Beginning fin. goods inv. (200 units x $900) 180,000
Cost of goods mfg (5,000 units x $900) 4,500,000
Goods available for sale 4,680,000
Ending fin. goods inventory 0
Cost of goods sold 4,680,000
Selling expense (5,200 units x $40) 208,000
Contribution margin 5,512,000
Less fixed expenses:
Manufacturing overhead 1,200,000
Selling expense 100,000
Administrative expense 500,000
Net income 3,712,000
Abosorption Costing Income Statement
Sales (5,200 units x $2,000) 10,400,000
Less cost of goods sold:
Beg. Fin. goods inv. (200 units x $1,140) 228,000
Cost of goods mfg (5,000 units x $1,140) 5,700,000
Goods available for sale 5,928,000
End. fin. goods inv. 0
Cost of goods sold 5,928,000
Gross margin 4,472,000
Operating expenses:
Selling expenses ($100,000 + (5,200 units x $40) 308,000
Administrative expenses 500,000
Net operating income 3,664,000
Reconciliation of the operating income between variable costing and absorptioncosting
Variable costing net income 3,712,000
- Fixed manufacturing overhead released from
beginning inventory
200 units x $240 48,000
+ Fixed manufacturing overhead deferred in
ending inventory
0 units x $240 0
Absorption costing net income 3,664,000
A Comparison of IncomesAbsorption Net Income
Variable Net Income
Year 1(Production = Sales)
3,500,000 3,500,000
Year 2(Production > Sales)
3,336,000 3,288,000
Year 3(Production < Sales)
3,664,000 3,712,000
3 Year Totals 10,500,000 10,500,000When total production over the 3 year period = total sales over thatperiod, total net income under the approaches is equal.
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