Ch. 9 Notes - Copyright © Rowland Atiase, 2009 9/9f09...

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Unformatted text preview: Copyright © Rowland Atiase, 2009 9/9f09 Chapter 9 Day 1 HO Income Effects of Afltomative Inventory/Product Costing Methods 1. Introduction. 11.. Comparison of Actual/Normal/Standard Direct v. Absorption Costing II a. Throughput Costing III. Arguments For/Against Direct & Absorption Costing IV. Difference in NEAC 8; NIDC V. CVP under AC & DC Copyright © Rowland Atiase, 2009 9/9/09 Chapter 9. Income Effects of Alternative inventory/Product Costing Methods 1. Introduction The purpose of this chapter is to examine and compare the effects of some costing alternatives on the measurement of product costs and income. Direct Costing = Variable Costing = Marginal Costing Absorption Costing m Conventional Costing m Traditional Costing The basic distinction between Direct & Absorption Costing lies in the treatment of Fixed Manufacturing Overhead g FOH g. Under®sting FOH is NOT inventorized. FOH is treated as a period cost. Under @osting FOH is inventorized, i.e., treated as a product cost. Copyright © Rowland Atlase, 2009 9/9/09 11. Comparison of Actual/N ormal/ Standard DIRECT v. ABSORPTION COSTING: An Overview (K. Rowland Atiase) Direct Costing/Variable Costing/Marginal Costing Absorption Costing/ Conventional Costing/Traditional Costing Ch.2 ' Chs. '4 015.73 Actual Costing Normal Costing Standard Costing Absorption Actual PC*. + Actual PC + Standard PC + Costing Actual VOH + Applied VOH ~I- Standard VOH + Actual F OH Applied'FOH Standard FOH Direct Actual PC + Actual PC + Std PC + Costng Actual VOH Applied -OH * PC = Prime Cost (DM + DL) Std VOH Only Absorption Costing is allowed for external financial reporting as a generally accepted accounting principle (GAAP) and for income tax (IRS) purposes. Thus Direct Costing is neither a GAAP nor is it acceptable for income tax purposes. However, the contribution margin approach of Direct Costing makes it more useful W for internal reporting purposes. m Copyright © 'Rowiand Atiase, 2009 9/9/09 11 a. Throughput Costing (Also called Super—Variable Costing) Some critics maintain that only Direct Materials are “truly variable” and propose Throughput Costing be used. Throughput Costing treats all costs except those related to Variable Direct Materials as eosts of the period. in which they are incurred. Under Throughput Costing, only Variable Direct Material costs are inventorized. - The proponents argue that even Variable Costing promotes an excessive amount of costs being inVentorized. This method-i5 a recent proposal and currently has. not achieved widespread use by companies even for internal use. Copyright © Rowland Atiase, 2009 9/9/09 Hi. Arguments For/Against Direct dz Absorption Costing Direct Costing has been a controversial subject among accountants —- not so much because there is disagreement about the need for delineating between Variable 82: Fixed Cost behavior patterns for management planning and control, but beCause there is a question about its theoretical propriety for external reporting. Proponent of Direct Costin maintains that F OH is more closel W related to the CAPACITY to reduce code in genergl rather than the production of specific units. Therefore FOH shouid be charged to the period. OWWM variable costs are necessa to reduce oods. Thus, both of these costs should be inventoriabie, regardiess of their difference in cost behavior patterns. Neither the public accounting profession nor the IRS has approved Direct Costing as generally accepted accounting principle (GAAP) for inventory valuation. Only Absorption costing is allowed for external financial reporting and for IRS purposes. (Note, however that Direct Costing is not prohibited for such purposes in Canada). Thus, Absorption Costing is much more widely used than Direct Costing. However, the growing use of the Contribution margin . approach in performance measurement and cost analysis has led to increased use of Direct Costing for internai (reporting ) purposes. DFVCC‘i’ COS'f‘i'j/CM fippramfll #9 ink/remap vapor-Hug fvaa 5¢5 AbSOrp-fw‘om (Les-Haj *4}? Gfiflp Copyright © Rowiand Atiase, 2009 ‘ 9/9/09 IV. Difference in NIAC & Nine Central Issue~ was»: W are/[case one POM h expow5¢ a) Direct Costing~ FOH expanse»? m m Par-faoQ {kome b) Absorption Costingw Foe—l expmsd M m owe W 9:70an 1—» uni/ooh m POM {‘5 rdmc-fl We soup 0) In the long run, assuming no BI and 110 E1, Tot-09 NI“ n “n+4? MM In general, the only difference between the 2 methods is that AC traps some F OH in inventory. Consequenfiy, the difference in NIAC & NIDC must be in the change in the amount of FOE that AC (flagged; held in Endin vs Beginning inventory values. Thus, MAG-Mm: FOHEl - FOHM (I) (See Appendix 1, AAB or H.O. #3A for proof.) Copyright © Rowland Atiase, 2009 9/9/09 Numerical Example FOHB = $100 05+ dhw r thovyucwr I‘vww‘w Laud —m = 100 units 4/ (“Li'sif’fi‘f‘fifWM F 2 FOHB / D = $1 mm: 131 m 0 Vp = 100 units Vs = 70 units Then, FOH charged to period under DC = $100 FOH charged to period under AC w __$]_Q Difference = 1m NIAC - NIDC = FOHE; - FOHBI = 30 — 0 ii 30 Copyflght © Rowland Atiase, 2009 9/9/09 For ease of exposition, we make the following assumptions which hold throughout the remainder of the Paper: Let: 7* The amount ofFOH in workminmprocess inventories does not change from one period to the next. Since FOH is not appiied to raw materials and since we assume that FOE in workwinuprocess does not change, only the finished goods inventory is of interest for purposes of this paper. Consequently, we will use the terms finished goods (PG) and inventory interchangeably. Within each period, the fixed manufacturing overhead rate-is equal for all units. In other words, there is only one product. E1 = Ending inventory BI m Beginning inventory UAO m Under—applied overhead 0A0 = Overwapplied overhead FOHR = Fixed overhead rate FW simptf‘u'fib Jud-l» look 54' PC: inum‘fwn/ Copyright © Rowland Atiase, 2009 9/9/09 Case I Here we assume that the FOH rate changes from period to period and any under/overuapplied FOH is prorated to inventories and cost of goods sold (CGS). Then, from equation (I): Shark: 9'; NIACWNIDCW ( FOH Amati-cats, 3; Mo (mam) W (Fol-l amt-cat t 5W‘ "a “*4” (WWW/#91920" 8' '" FOH Preer 11: (31 / z I: (FOHR ED ( Marts“) + uaog, (~. meg] (2) ‘— [(F0HK r31)( («LIA-{(PSBI) + “A 08, (- Old-03’) ] (Depending on the cost flow assumption [e.g., FIFO, LIFO], different inventory layers may have different P OH rates. In this case, the number of _ units in layer is multiplied by the FOHR for that layer, and values for all layers are summed to obtain the Applied POI-i.) Case 11 The FOH rate changes, but any under/overnapplied FOH is charged only to CGS. Then, NIAC —- NIDC : F 0 HA Applu‘wgfl - FOH Applficflm as , (3) 2 (Fame “yum,” a) - (amass, Copyright © Rowland Atiase, 2609 9/9/09 Case 111 Assume that the FOH rate does not change, but under/over—applied FOH is prorated. Then,- NIAC «— NIDC = (FOH Appliedgl i Share of Under(0ver) Appiied) FOH Prorated to E1 ; (FOE AppliedB; i Share of Under(0ver) Applied) F OH Prerat-ed to BE =[(FOHR)(#UnitsEI)+UAOEICMOAOEI)] —— [(FOHR)(#UnitsBI)+UAOBI(WOAOBIE (4) Case IV Assume that the FOH rate does not change and any under/Over—appl’ied FOH is charged to CGS. Then NIACWNIDC: ( {£4 ~ 5M6 O'F Mme?“ t1 . 4" Prov ‘ E] W , . ‘1 ‘3 5 Te 0'? V‘GEW 0‘ Mm 994 PH PP: m '3' r V ) > I? OH buth ‘ + [Min ! (,Op‘.‘ 1 ( HR) W B!) + i Om ("0 3‘ z” k‘ E (A )nv‘bwhvy M inf-k5) (See Horngren, Foster & Datar) N0“: Wl/K—DA FOHR as I.“ Cases IW’Wg—Yr +44 ; I Cafe #560 aSSW/gv‘w‘avt (“-3- FIFO, LIFO) My «Hui Comvafi-Jw'avx 0-? +04 afPIr‘eog POM “PW 'HM V‘M‘C‘TWS [wumhvxj lqms. Copyright © Rowland Atiase, 2009 ' 9/9/09 EXfli’flfiiBS of Inventory Layers & Cost flow Assumption Example __(.1.)._ .iZL BI 3,000 3,000 VP 8,000 8,000 Total Available 11,000 11,000 VS (9,000) (7,000) El 29000 "fl-2000 units (1) FIFO LIFO FOHRBI B) 13} FOI—IREI VP :3; ’82:": 6"," 2 5.2.1 (2) Formm 13* 8! POI-IRE; VP [,000 \./P 1 El 3.000 Bl V. CV1) under AC & DC NIDC W f(sales only) MAC : f(sales, production) Question: Can a company report a positive NIAC when sales are zero? Answer: Y1: S Copyright © Rewiand Atiase, 2009 LET: CVP' Notation for the derivation of CVP Relation under Absorption Costing (AC) and Direct Costing gDC: Selling I)rice/unit m P Variable Manufacturing Cost/unit : Vm Denominator Activity Level = D Fixed Manufacturing OH Budget: 5 FOHB Fixed Manufacturing Rate m FOHB = F Volume of Units Produced = Vp Volume of Units Sold m VS Variable Selling & Admin. Expenses/unit = V5&A Fixed Selling & Admin. Expenses | 1-1-5 m 2° 11> 9/9/09 Copyright © Rowland Atiase, 2009 9/9/09 THEN NOTE: CM/U = (P — Vm _ VS&A) By Assumption, Actual FOH = FOHB m F - D Applied FOH = F - Vp Therefore, Under(over) applied FOH = FD ~ FVp m F03 —— Vp) CVP under AC & DC Absorption Costing Income Statement Sales X P - VS Less CGS Normal VC of GS X JVm - VS Normal PC of GS X —F - VS [5(0) Applied FOH X —F(D -— Vp) Adjusted CGS _X Gross Margin ' XX Gross 7: Less Variable Selling & Admin. (X) —V3&A ' VS Fixed Selling & Admin. (X) -FS&A NIAC @ 5,14; Copyright (C) Rowlané Atiase, 2009 9/9/09 NIAC = (P - Vs) - (Vm - Vs) W (F - Vs) - Fa) - Vp) - (VsaA - Vs) —- FS&A MAC "7- (P - Vs) - (Vm ’ Vs) - (Vsaa - Vs) W (F - Vs) _ FS&A - F(D ~ Vp) ~ WF8&A +F(§D—VP)+NI V AC S CM / unit - F ((11) in AAB, p. 274) This defines CV'P under AC”, and (i) NIAC "-“ RVs: Vp) One can no longer ask the question of simply how many units must be ‘sold to generate some NI, because MAC is a function of both VS and Vp. However, given any 2 of the 3 variables VS, Vp, and NIAC, we can find the third. Note under DC the CVP relationship is: FD NI VZFS&A+ + DC S CM / unit (ii) NIDC fl f(sales only) In the long run, assuming no B1 and no E1, (iii) Total NIDC = Total NIAC Copyright © Rowland Atiase, 2009 9/9/09 Hints and Assumptions for Chapter 9, Part 1 I.- II. III. Assume that all actual costs and selling prices equal Budgeted Costs and Selling Prices. This implies that: a. The Budget Variance W 0, and b. Production Volume Variance m Under (over) Applied Fixed Manufacturing Overhead Hints for Problem 9—29 a. Assume Normal Costing. b. Work the problem under 2 alternatives: Alternative 1 - Assume Denominator Activity Level (D) m 20,000 units/year Alternative 2 - Assume D = 10,000 units/year c. Assume any under (over) applied OH is charged to Cost of Goods Sold. Problem 9—23, Requirement 3b Assuming LIFO, What is the difference between Absorption and Direct Costing Net Incomes in Year 2? ...
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Ch. 9 Notes - Copyright © Rowland Atiase, 2009 9/9f09...

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