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Variable Costing: A Tool for Management Variable Costing: A Tool for Management

Variable Costing: A Tool for Management - PowerPoint Presentation

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Variable Costing: A Tool for Management - PPT Presentation

Learning Objectives Explain how variable costing differs from absorption costing Compute the unit product cost under each method Prepare income statements using variable and absorption costing and reconcile the two income figures ID: 756656

costing variable income costs variable costing costs income segment 000 absorption fixed overhead cost inventory product statement common sales

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Slide1

Variable Costing: A Tool for ManagementSlide2

Learning Objectives

Explain how variable costing differs from absorption costing

Compute the unit product cost under each method

Prepare income statements using variable and absorption costing, and reconcile the two income figures

Describe how fixed overhead costs are deferred in, and released from, inventory under absorption costing

Explain the advantages and limitations of variable and absorption

costing

Prepare a segmented income statement

and

use

it.

Compute companywide and segment break-even

points.

Prepare

income statements

using super-variable costing and reconcile this approach with variable

costing

.Slide3

Variable Vs. Absorption Costing

Direct Materials

Direct Labor

Variable Manufacturing Overhead

Fixed Manufacturing Overhead

Variable Selling and Administrative Expenses

Fixed Selling and Administrative Expenses

Variable

Costing

Absorption

Costing

Product

Costs

Period

Costs

Product

Costs

Period

CostsSlide4

Quick Test

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. . .Slide5

Quick Test

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. . .Slide6

Variable Vs. Absorption Costing Example

Mickey produces a product with a selling price of $100/unit. The following information is available for the first year.Slide7

Unit Cost Calculations

Selling and administrative expenses are

always treated as

period costs

.Slide8

Income Statement – Absorption Costing

Full mfg. costs

Fixed

manufacturing

overhead is

allocatedSlide9

Income Statement – Variable Costing

Variable

mfg. costs

only

All fixed

manufacturing

overhead is

expensedSlide10

Variable Vs. Absorption Costing Example

In its second year of operation, Mickey accumulated the following information:Slide11

Unit Cost Calculations

Selling and administrative expenses are

always treated as

period costs

.Slide12

Income Statement – Absorption Costing

Fixed

manufacturing

overhead is

allocated

Full mfg.

costsSlide13

Income Statement – Variable Costing

Variable

mfg. costs

only

All fixed

manufacturing

overhead is

expensedSlide14

Notes

If production > sales (inventory level increases), income (absorption) > income (variable).

Fixed overhead is partially deferred in inventory under absorption costing.

If production < sales (inventory level decreases), income (absorption) < income (variable).

Deferred fixed overhead is released to income statement under absorption costing.

If production = sales (inventory level is the same), Income (absorption) = Income (variable).Slide15

Reconciliation

In general, the difference in income between absorption and variable costing is the change in inventory value under absorption minus the change in inventory value under variable costing.

However, if unit cost does not change (or if there is no beginning inventory), then:

Income (absorption) - Income (variable) = Fixed overhead per unit * Change in inventory level

where, change in inventory level =

production - sales, or EI - BI, in units.Slide16

Reconciliation

We can reconcile the difference between

absorption and variable income as follows:Slide17

Reconciliation

Alternatively, we can reconcile the differences between absorption and variable income as follows:Slide18

Arguments For Variable Costing

Should we allocate Fixed overhead to units of output?

Is fixed overhead a product cost (an asset) or a period cost (an expense)?

Variable costing approach blends well (ties in) with CVP analysis, budgeting, segment reporting, etc.

Income under absorption costing may be manipulated by changing the production level.

In 1970s and 1980s, variable costing was used for internal use, but the trend is reversing because fixed overhead is becoming a major part of product cost.Slide19

Impact of JIT Inventory System

In a JIT inventory system . . .

production

tends to equal

sales . . .

So, the difference between variable and

absorption income tends to disappear.Slide20

Segment

Definition

and Overview

A segment is any part of an entity for which it is useful to collect revenue, cost, or profit data.

A segment can be

A Customer

A Sales Territory

A Service Center

Dental officeSlide21

Segment Reporting

Segment reporting refers to reports (income statements) that focus on various segments of an entity.

The objective of segment reporting is to provide information on the profitability of segments.

An entity can be segmented based on:

a single criterion at a time (e.g., product lines, products, sales territories)

multiple criteria, or

a combination.Slide22

Segmenting an Entity – Example

Sales

Territories

Regal Company

Products

Product

LinesSlide23

Segment Income Statement

Segment income statement follows the contribution approach.

The fixed costs are, however, further divided into traceable and common.

Traceable (Direct) costs of a segment are costs that are directly related to that segment

or

can be reasonably allocated to it.

Common (Indirect) costs are costs that are not directly related to any segment and cannot be reasonably allocated to segments.Slide24

Identifying Traceable Fixed Costs

Traceable costs

would disappear over time if the segment itself disappeared.

No computer

division manager

No computer

division means . . .Slide25

Identifying Common Fixed Costs

Common costs

would not disappear if the segment were eliminated

.

No computer

division but . . .

We still have a

company president.Slide26

Segment Income Statement

Company

Television

Appliance Computer

Sales $600,000 $300,000 $100,000 $200,000Variable CGS (215,000) ( 90,000) (75,000) (50,000)Other V.C. (100,000)

( 60,000) (10,000) (30,000)

Contribution margin 285,000 150,000 15,000 120,000Traceable F.C. (180,000) ( 90,000)

(10,000) ( 80,000)Segment margin 105,000 60,000

5,000 40,000Common F.C. ( 25,000)

Net Income 80,000Slide27

Segment Income Statement

Each segment is charged only for its traceable costs. Common costs of the organization are not charged/allocated to segments.

Traceable costs can become common if the company is divided into smaller segments.

Contribution margin data is useful as a short-term planning tool since it:

reveals the effect of a change in sales volume on income

facilitates decisions on temporary uses of capacity, special orders, and product promotionSlide28

Segment Income Statement

Segment margin represents the amount that the segment contributes toward the recovery of the common F.C. and then earning a profit.

Segment margin is the best gauge of the long-run profitability of a segment. It is useful for:

long-run capacity changes and pricing decisions

evaluating segments’ performance (i.e., decisions to retain or eliminate segments)

evaluating segment managers’ performance (some would argue that committed FC should be excluded)Slide29

Quick TestSlide30

Quick Test

How much of the common fixed cost of $200,000 can be avoided by eliminating the bar?

a. None of it.

b. Some of it.

c. All of it.Slide31

Quick Test

How much of the common fixed cost of $200,000 can be avoided by eliminating the bar?

a. None of it.

b. Some of it.

c. All of it.Slide32

Hindrances of Proper Cost Assignment

Omission of some costs in the assignment process

All costs, manufacturing or not, should be assigned.

Use of inappropriate methods for cost allocation

Traceable costs should not be allocated.

Costs that are not easily traceable should not be allocated on an arbitrary basis.

Allocation base should be appropriate.Assignment of common costs of the organizationCommon cost of the organization arise because of overall operating activities and should not be assigned.Slide33

Companywide and Segment

Break-Even

P

oints

Companywide break-even

point is computed by dividing the sum of the company’s traceable fixed expenses and common fixed expenses by the company’s overall contribution margin ratio.A

segment’s break-even point is computed by dividing its traceable fixed expenses by its contribution margin ratio. Slide34

Variable vs. Super-Variable Costing

Super-variable

costing classifies all direct labor and manufacturing overhead costs as fixed period costs and only direct materials as a variable product

cost.

Direct Materials

Direct Labor

Fixed Manufacturing Overhead

Fixed Selling and Administrative Expenses

Variable

Costing

Super-

Variable

Costing

Product

Costs

Period

Costs

Product

Cost

Period

Costs