Prepared by Debby Bloom-Hill CMA, CFM
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CHAPTER 5CHAPTER 5
Variable CostingVariable Costing
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Full (Absorption) CostingFull (Absorption) Costing
Required by GAAP for external reporting purposes
Inventory costs include: Direct materials used
Generally variable Direct labor incurred
Generally variable Manufacturing overhead
Includes both fixed and variable costs
Learning objective 1: Explain the difference between full (absorption) and variable costing
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Variable CostingVariable Costing
Inventory costs includes: Direct materials used Direct labor incurred Variable manufacturing overhead
Fixed manufacturing overhead treated as a period cost
Helpful for internal decision making
Not allowed for GAAP reportingLearning objective 1: Explain the difference between full (absorption) and variable costing
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Which of the following complies with GAAP for external reporting purposes?
a. Absolute costingb. Variable costingc. Fixed costingd. Full costing
Answer:d. Full costing, also known as
absorption costing
Learning objective 1: Explain the difference between full (absorption) and variable costing
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Full (Absorption) CostingFull (Absorption) Costing
Learning objective 1: Explain the difference between full (absorption) and variable costing
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Variable CostingVariable Costing
Learning objective 1: Explain the difference between full (absorption) and variable costing
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Difference Between Full and Variable Costing
Difference Between Full and Variable Costing
The only difference between full and variable costing is their treatment of fixed manufacturing overhead Under full costing, fixed
manufacturing overhead is included in inventory These costs enter into the
determination of expense only when the inventory is sold
Under variable costing, fixed manufacturing overhead becomes a period expense
Learning objective 1: Explain the difference between full (absorption) and variable costing
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Variable Costing Income Statement
Variable Costing Income Statement
Classifies all expenses in terms of their cost behavior, either fixed or variable With variable and fixed expenses
separated, the contribution margin can be presented Contribution margin is revenues minus
total variable expenses The contribution margin allows users
to make reasonable estimates of how much profit will change with changes in sales
Learning objective 2: Prepare an income statement using variable costing.
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Sales are $100,000 and contribution margin is $65,000
Calculate the contribution margin ratio:
Calculate the change in contribution margin if sales change by $10,000
$10,000 * 0.65 = $6,500
Learning objective 2: Prepare an income statement using variable costing.
Variable Costing Income Statement
Variable Costing Income Statement
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Variable Costing Income Statement Example
Variable Costing Income Statement Example
Learning objective 2: Prepare an income statement using variable costing.
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Full Costing Income Statement Example
Full Costing Income Statement Example
Learning objective 2: Prepare an income statement using variable costing.
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The full costing income statement cannot be used to estimate the increase in profit due to an increase in sales The reason is that cost of goods sold
includes both fixed and variable costs
The fixed costs will not increase when sales increase Under full costing we do not know how
much of cost of goods sold is fixed or variable Learning objective 2: Prepare an
income statement using variable costing.
Variable Costing vs. FullCosting Income StatementVariable Costing vs. Full
Costing Income Statement
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Example - Clausen Tube Example - Clausen Tube
Selling price $2,000 Variable costs (per unit):
Materials = $600/unit Labor = $225/unit Variable mfg. overhead = $75/unit Variable selling expense = $40/unit
Fixed mfg. overhead = $1,200,000
Production = 5,000 units
Learning objective 3: Discuss the effect of production on full and variable costing income.
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Clausen TubeFull Cost per Unit
Clausen TubeFull Cost per Unit
Full cost per unit for 5,000 units is calculated as follows:
Learning objective 3: Discuss the effect of production on full and variable costing income.
Total Material Costs
$600 per unit
Total labor costs $225 per unit
Total variable OH $75 per unit
Fixed Overhead $1,200,000/5,000 units
$240 per unit
Full Cost per Unit = $1,140 per unit
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Clausen TubeVariable Cost per Unit
Clausen TubeVariable Cost per Unit
Variable cost per unit for 5,000 units is calculated as follows:
Learning objective 3: Discuss the effect of production on full and variable costing income.
Total Material Costs $600 per unit
Total labor costs $225 per unit
Total variable OH $75 per unit
Variable Cost per Unit = $900 per unit
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Clausen Tube – Income Statement
Clausen Tube – Income Statement
Selling price = $2,000/unit Full cost = $1,140/unit Variable cost = $900/unit Variable selling expense = $40/unit Fixed overhead = $1,200,000 Fixed selling expense = $100,000 Fixed administrative expense=
$500,000
Learning objective 3: Discuss the effect of production on full and variable costing income.
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Clausen Tube – Income Statements
Clausen Tube – Income Statements
Production equals sales (5,000 units)
Sales 5,000 x $2,000 = 10,000,000 Cost of goods sold 5,000 x $1,140 = 5,700,000 Gross margin 4,300,000 Selling & Admin Expenses* 800,000 Net Income 3,500,000
Sales 5,000 x $2,000 = 10,000,000 Variable costs 5,000 * ($900 + $40) 4,700,000 Contribution margin 5,300,000 Fixed costs** 1,800,000 Net Income 3,500,000
Full Cost
Variable Cost*100,000 + 500,000 + (5,000 x $40)
**1,200,000 + 100,000 + 500,000
Learning objective 3: Discuss the effect of production on full and variable costing income.
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Quantity Produced Equals Quantity Sold
Quantity Produced Equals Quantity Sold
When the quantity produced equals the quantity sold, there is no difference between net income calculated using full cost versus variable costing Since all units produced are sold, no
fixed cost ends up in ending inventory The only difference is that variable
costing calculates the contribution margin
Learning objective 3: Discuss the effect of production on full and variable costing income.
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Clausen Tube – Income Statements
Clausen Tube – Income Statements
Production (6,000 units) is greater than sales (4,800 units)
Sales 4,800 x $2,000 = 9,600,000 Cost of goods sold 4,800 x $1,100 = 5,280,000 Gross margin 4,320,000 Selling & Admin Expenses* 792,000 Net Income 3,528,000
Sales 4,800 x $2,000 = 9,600,000 Variable Costs 4,800 * ($900 + $40) 4,512,000 Contribution margin 5,088,000 Fixed Costs** 1,800,000 Net Income 3,288,000
Full Cost
Variable Cost*100,000 + 500,000 + (4,800 x $40)
**1,200,000 + 100,000 + 500,000
Learning objective 3: Discuss the effect of production on full and variable costing income.
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Quantity Produced is Greater Than Quantity Sold
Quantity Produced is Greater Than Quantity Sold
When the quantity produced is greater than the quantity sold income will be greater under full costing as opposed to variable costing Under full costing, inventory cost
includes fixed manufacturing overhead Under variable costing, fixed
manufacturing overhead is a period cost
Learning objective 3: Discuss the effect of production on full and variable costing income.
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Clausen Tube – Income Statements
Clausen Tube – Income Statements
Production (6,000 units) is less than sales (7,200 units)
Sales 7,200 x $2,000 = 14,400,000 Cost of goods sold 7,200 x $1,140 = 7,920,000 Gross margin 6,480,000 Selling & Admin Expenses* 888,000 Net Income 5,592,000
Sales 7,200 X 2,000 = 14,400,000 Variable costs 7,200 * ($900 + $40) 6,768,000 Contribution margin 7,632,000 Fixed costs** 1,800,000 Net Income 5,832,000
Full Cost
Variable Cost*100,000 + 500,000 + (7,200 x 40)
**1,200,000 + 100,000 + 500,000
Learning objective 3: Discuss the effect of production on full and variable costing income.
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Quantity Produced is Less Than Quantity Sold
Quantity Produced is Less Than Quantity Sold
Then the quantity produced is less than the quantity sold, income will be greater under variable costing as opposed to full costing Beginning inventory under fixed costing
includes fixed manufacturing overhead When the beginning inventory is
charged to cost of goods sold the charge will be higher under full costing
Learning objective 3: Discuss the effect of production on full and variable costing income.
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Variable Costing for External Reporting
Variable Costing for External Reporting
Learning objective 3: Discuss the effect of production on full and variable costing income.
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Summit Manufacturing, Inc. produces snow shovels. The selling price is $25. Costs are:
Materials 4 Labor 3 Variable overhead 2 Fixed overhead 168,000 Variable selling & admin 1 Fixed selling & sdmin 152,000 Full cost per unit
Production is 42,000 snow shovels. Calculate full cost per unit.
Learning objective 3: Discuss the effect of production on full and variable costing income.
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Summit Manufacturing, Inc. produces snow shovels. The selling price is $25. Costs are:Materials 4 4Labor 3 3Variable overhead 2 2Fixed overhead 168,000 168,000 / 42,000 4Variable selling & admin 1 Fixed selling & sdmin 152,000 Full cost per unit 13
Full Cost
Production is 42,000 snow shovels. Full cost is $13 per unit.
Learning objective 3: Discuss the effect of production on full and variable costing income.
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Summit Manufacturing, Inc. produces snow shovels. The selling price is $25. Costs are:
Materials 4 Labor 3 Variable overhead 2 Fixed overhead 168,000 Variable selling & admin 1 Fixed selling & sdmin 152,000 Full cost per unit
Production is 42,000 snow shovels. Calculate variable cost per unit.
Learning objective 3: Discuss the effect of production on full and variable costing income.
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Summit Manufacturing, Inc. produces snow shovels. The selling price is $25. Costs are: Variable Cost
Materials 4 4Labor 3 3Variable overhead 2 2Fixed overhead 168,000 Variable selling & admin 1 Fixed selling & sdmin 152,000 Variable cost per unit 9
Production is 42,000 snow shovels. Variable cost is $9 per unit.
Learning objective 3: Discuss the effect of production on full and variable costing income.
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Impact of Method Selection on Income Statement
Impact of Method Selection on Income Statement
Units produced = units sold No difference in net income
Units produced greater than units sold Full costing yields higher net
income Units Produced less than units
sold Variable costing yields higher net
income
Learning objective 3: Discuss the effect of production on full and variable costing income.
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Reducing ProductionReducing Production
Learning objective 3: Discuss the effect of production on full and variable costing income.
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Kincade Faucets produces a variety of faucets. During the year, the company incurred $400,000 of depreciation expense on its manufacturing equipment. How much depreciation expense will be in Finished Goods Inventory under variable costing?
a. $400,000b. $285,714c. $0d. None of the above
Answer:a. Depreciation is a fixed cost which is
expensed as a period cost under variable costing
Learning objective 3: Discuss the effect of production on full and variable costing income.
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Impact of JIT on IncomeImpact of JIT on Income
Companies using JIT typically have low levels of inventory
Units produced are approximately equal to units sold
Difference between full costing and variable costing is likely to be very small.
Learning objective 4: Explain the impact of JIT on the difference between full and variable costing income
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Benefits of Variable Costing for Internal Reporting
Benefits of Variable Costing for Internal Reporting
Variable costing facilitates cost-volume-profit (CVP) analysis Separates fixed and variable costs Allows managers to accurately
estimate the impact of changes in volume on cost and profit
Cannot be answered using full costing
Learning objective 5: Discuss the benefits of variable costing for internal reporting purposes
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Benefits of Variable Costing for Internal Reporting
Benefits of Variable Costing for Internal Reporting
Variable costing limits management of earnings via production volume Managers are often compensated
based on income in their division Full costing produces higher income
when production is greater than sales
Managers have an incentive to manage earnings under full costing
Learning objective 5: Discuss the benefits of variable costing for internal reporting purposes
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Impact of Changes in SalesImpact of Changes in Sales
Learning objective 5: Discuss the benefits of variable costing for internal reporting purposes
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