202 Ch 7 S08 S

202 Ch 7 S08 S - ACC 202 Intro to Management Accounting...

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Unformatted text preview: ACC 202 Intro to Management Accounting Chapter 7: Variable Costing: A Tool for Management obj 1 Learning Objectives Compute product costs using variable costing Understand the difference between variable and absorption costing Reconcile variable costing and absorption costing net income Product Costs Absorption Costing Product costs include all manufacturing costs (fixed and variable) AKA Full Costing Variable Costing Product costs include only variable manufacturing costs AKA Direct Costing or Marginal Costing Components of Absorption & Variable Product Cost Absorption Costing Direct Materials Direct Labor Variable Manufacturing Overhead Fixed Manufacturing Overhead Variable Costing Product Costs Product Costs Period Costs Variable Selling and Administrative Expenses Fixed Selling and Administrative Expenses Period Costs 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. . . Unit Cost Computations Harvey Company produces a single product: 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 25,000 $ $ 10 3 $ 150,000 $ 100,000 Unit Cost Computations Absorption Costing Direct materials, direct labor, and variable mfg. overhead Fixed mfg. overhead ($150,000 25,000 units) Unit product cost $ 10 6 16 Variable Costing $ 10 10 $ $ Selling and administrative expenses are always treated as period expenses and deducted from revenue as incurred. Income Comparison of Absorption and Variable Costing More year 1 info for Harvey Company: 20,000 units sold at $30 each No units in beginning inventory Compute net income using both absorption and variable costing. Absorption Costing Yr 1 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 $ 600,000 320,000 280,000 160,000 $ 120,000 Variable Costing Yr 1 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 Variable manufacturing Variable Costing costs only. $ 600,000 All fixed manufacturing overhead is expensed. 260,000 340,000 250,000 $ 90,000 Fixed MOH Comparison in Absorption & Variable Costing Fixed MOH treatment is the only difference in product costs. Cost of Goods Sold Absorption costing Variable mfg. costs $ 200,000 Fixed mfg. costs 120,000 $ 320,000 Variable costing Variable mfg. costs $ 200,000 Fixed mfg. costs $ 200,000 Ending Inventory $ 50,000 30,000 $ 80,000 Period Expense $ $ Total $ 250,000 150,000 $ 400,000 $ 50,000 $ 50,000 $ 150,000 $ 150,000 $ 250,000 150,000 $ 400,000 Net Income Reconciliation Reconcile the difference between absorption and variable income in year 1 : 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 = = $6.00 per unit Units produced 25,000 units Q: Why Are There Two Methods? A: Beliefs differ about how to treat fixed costs. Absorption Costing All costs should be matched w/ revenue Minimizes changes in net income caused by changes in inventory levels between periods Required for all external reporting Variable Costing Fixed costs are incurred regardless of revenue levels so period cost treatment gives a more "accurate" view of the financial picture Facilitates budgets and CVP analysis Only used internally Extended Comparison Harvey Company Year 2 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 25,000 30,000 5,000 $ 30 $ $ 10 3 $ 150,000 $ 100,000 Unit Cost Computations Absorption Costing Direct materials, direct labor, and variable mfg. overhead Fixed mfg. overhead ($150,000 25,000 units) Unit product cost $ 10 6 16 Variable Costing $ 10 10 $ $ Since there was no change in the variable costs per unit, total fixed costs, or the number of units produced, the unit costs remain unchanged. Absorption Costing Yr 2 Absorption Costing Sales (30,000 $30) Less cost of goods sold: Beg. inventory (5,000 $16) Add COGM (25,000 $16) Goods available for sale Less ending inventory Gross margin Less selling & admin. exp. Variable (30,000 $3) Fixed Net operating income $ 900,000 $ 80,000 400,000 480,000 - 480,000 420,000 $ 90,000 100,000 190,000 $ 230,000 These are the 25,000 units produced in the current period. Variable Costing Yr 2 Variable manufacturing costs only. Variable Costing $ 900,000 Sales (30,000 $30) Less variable expenses: Beg. inventory (5,000 $10) $ 50,000 Add COGM (25,000 $10) 250,000 Goods available for sale 300,000 Less ending inventory Variable cost of goods sold 300,000 Variable selling & administrative expenses (30,000 $3) 90,000 Contribution margin Less fixed expenses: Manufacturing overhead $ 150,000 Selling & administrative expenses 100,000 Net operating income All fixed manufacturing overhead is expensed. 390,000 510,000 250,000 $ 260,000 Net Income Reconciliation Reconcile the difference between absorption and variable income in year 2 : 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 Fixed mfg. Overhead $150,000 = = $6.00 per unit Units produced 25,000 units Income Comparison Costing Method Absorption Variable 1st Period $ 120,000 90,000 2nd Period $ 230,000 260,000 Total $ 350,000 350,000 Summary Comparison Relation between production and sales Production > Sales Effect on inventory Inventory increases Inventory decreases Relation between variable and absorption income Absorption > Variable Absorption < Variable Absorption = Variable Production < Sales Production = Sales No change Effect of Changes in Production on Net Operating Income Let's revise the Harvey Company example. 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. Effect of Changes in Production Harvey Company Year 1R Number of units produced Number of units sold 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 30,000 25,000 $ 30 $ $ 10 3 $ 150,000 $ 100,000 Unit Cost Computations Absorption Costing Direct materials, direct labor, and variable mfg. overhead Fixed mfg. overhead ($150,000 30,000 units) Unit product cost $ 10 5 15 Variable Costing $ 10 10 $ $ Since the number of units produced increased in this example, while the fixed manufacturing overhead remained the same, the absorption unit cost is less. Absorption Costing Yr 1R 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 $ 750,000 375,000 375,000 175,000 $ 200,000 Variable Costing Yr 1R 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 Variable manufacturing costs only. Variable Costing $ 750,000 All fixed manufacturing overhead is expensed. 325,000 425,000 250,000 $ 175,000 Effect of Changes in Production Harvey Company Year 2R 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 20,000 25,000 5,000 $ 30 $ $ 10 3 $ 150,000 $ 100,000 Unit Cost Computations Absorption Costing Direct materials, direct labor, and variable mfg. overhead Fixed mfg. overhead ($150,000 20,000 units) Unit product cost $ 10 7.50 17.50 Variable Costing $ 10 10 $ $ Since the number of units produced decreased in the second year, while the fixed manufacturing overhead remained the same, the absorption unit cost is now higher. Absorption Costing Yr 2R 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 - 425,000 325,000 $ 75,000 100,000 175,000 $ 150,000 These are the 20,000 units produced in the current period at the higher unit cost of $17.50 each. Variable Costing Yr 2R Variable manufacturing costs only. Variable Costing $ 750,000 Sales (25,000 $30) Less variable expenses: Beg. inventory (5,000 $10) $ 50,000 Add COGM (20,000 $10) 200,000 Goods available for sale 250,000 Less ending inventory 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 All fixed manufacturing overhead is expensed. 325,000 425,000 250,000 $ 175,000 Revised Income Comparison Costing Method Absorption Variable Year One $ 200,000 175,000 Conclusions Year Two $ 150,000 175,000 Total $ 350,000 350,000 Changes in production levels: Do not effect net income under variable costing. a. Do affect net income under absorption costing. Impact on the Manager Opponents of absorption costing argue that shifting fixed manufacturing overhead costs between periods can lead to misinterpretations and faulty decisions. Those who favor variable costing argue that the income statements are easier to understand because net income is only affected by changes in unit sales. The resulting income amounts are more consistent with managers' expectations. Disadvantages of Absorption Costing Does not support CVP analysis because it essentially treats fixed MOH as a variable cost (by assigning a per unit amount of the fixed overhead to each unit of production.) Therefore it can lead to faulty pricing decisions & keep / drop decisions, and Produces positive net income even when the number of units sold is less than the BE point. External Reporting & Income Taxes To conform to GAAP requirements, absorption costing must be used for external financial reports in the United States. Under the Tax Reform Act of 1986, absorption costing must be used when filing income Since top executives tax returns. are usually evaluated based on external reports to shareholders, they may feel that decisions should be based on absorption cost income. Advantages of Variable Costing & the Contribution Approach Consistent with CVP analysis. Management finds Net operating income it more useful. is closer to net cash flow. Consistent with standard costs and flexible budgeting. Easier to estimate profitability of products and segments. Impact of fixed costs on profits emphasized. Profit is not affected by changes in inventories. Advantages Variable vs. Absorption Costing Fixed manufacturing costs must be assigned to products to properly match revenues and costs. Fixed manufacturing costs are capacity costs and will be incurred even if nothing is produced. Absorption Costing Variable Costing Impact of Lean Production In a Lean Production environment . . . Production tends to equal sales . . . So, the difference between variable and absorption income tends to disappear. ...
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This note was uploaded on 08/25/2008 for the course ACC 202 taught by Professor Woollen during the Spring '08 term at Hawaii.

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