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
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Variable Costing: A Tool for Management
Slide2Learning 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
.
Slide3Variable 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
Costs
Slide4Quick 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. . .
Slide5Quick 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. . .
Slide6Variable Vs. Absorption Costing Example
Mickey produces a product with a selling price of $100/unit. The following information is available for the first year.
Slide7Unit Cost Calculations
Selling and administrative expenses are
always treated as
period costs
.
Slide8Income Statement – Absorption Costing
Full mfg. costs
Fixed
manufacturing
overhead is
allocated
Slide9Income Statement – Variable Costing
Variable
mfg. costs
only
All fixed
manufacturing
overhead is
expensed
Slide10Variable Vs. Absorption Costing Example
In its second year of operation, Mickey accumulated the following information:
Slide11Unit Cost Calculations
Selling and administrative expenses are
always treated as
period costs
.
Slide12Income Statement – Absorption Costing
Fixed
manufacturing
overhead is
allocated
Full mfg.
costs
Slide13Income Statement – Variable Costing
Variable
mfg. costs
only
All fixed
manufacturing
overhead is
expensed
Slide14Notes
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).
Slide15Reconciliation
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.
Slide16Reconciliation
We can reconcile the difference between
absorption and variable income as follows:
Slide17Reconciliation
Alternatively, we can reconcile the differences between absorption and variable income as follows:
Slide18Arguments 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.
Slide19Impact 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.
Slide20Segment
–
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 office
Slide21Segment 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.
Slide22Segmenting an Entity – Example
Sales
Territories
Regal Company
Products
Product
Lines
Slide23Segment 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.
Slide24Identifying Traceable Fixed Costs
Traceable costs
would disappear over time if the segment itself disappeared.
No computer
division manager
No computer
division means . . .
Slide25Identifying Common Fixed Costs
Common costs
would not disappear if the segment were eliminated
.
No computer
division but . . .
We still have a
company president.
Slide26Segment 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
80,000
Slide27Segment 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 promotion
Slide28Segment 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)
Slide29Quick Test
Slide30Quick 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.
Slide31Quick 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.
Slide32Hindrances 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.
Slide33Companywide 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.
Slide34Variable 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
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