Alternative Manufacturing Costing methods: Absorption Costing and Variable Costing (We assume below that there are

no economies of scale for DM, DL and MOH(V), i.e., these items are constant on a per unit basis regardless of production volume such as we have in Delta problem.) Absorption Costing (required by GAAP for external reporting): All manufacturing costs are treated as product costs (i.e. absorbed into product). All non-manufacturing costs are treated as period costs. Consequently, inventory is carried at Full Manufacturing Cost As production is increased (sales constant), per unit COGM falls - due to spreading fixed MOH over a greater number of units. Thus COGS falls, and net income rises to the extent that more fixed MOH is inventoried. (This feature may incentivize management to overproduce) Inventoried fixed MOH is released to the income statements (in COGS) in periods in which production is less than sales and inventory goes down. This results in net income being lower than what it would be if production were instead equal to sales. Variable Costing (not allowed by GAAP for external reporting but sometimes used internally for Management Control to avoid the incentives to overproduce that come with absorption costing): Only variable manufacturing costs (DM, DL, MOH(V)) are treated as product costs. Fixed MOH is treated as a period cost i.e., entirely expensed on the income statement regardless of level of production just as are all non-manufacturing costs. Changing production will not change Net Income as long as sales are constant. On the other hand, Inventory is carried only at variable manufacturing cost.

Delta Manufacturing Case B: Cost flows under Variable Costing July: (Delta starts and completes 1,200 widgets, sells 1,000) Direct Material Inventory OB 200,000 120,000 EB 80,000 Work-In-Process Inventory Finished Goods Inventory Cont. Marg. Format July Income St. 1,000 widgets sold Revenue $600,000 COGS (V) 300,000 S&A (V) 70,000 Cont. Mar. 230,000 MOH(F) 120,000 S&A (F) 80,000 NI 30,000 Aug. Income St. 1,000 widgets sold Revenue $600,000 COGS (V) 300,000 S&A (V) 70,000 Cont. Mar. 230,000 MOH(F) 120,000 S&A (F) 80,000 NI 30,000

OB 0 OB 0 DM 120,000 360,000 360,000 300,000 DL 180,000 COGM ($300 each) MOH(V) 60,000 EB 0 EB 60,000

August: (Delta starts and completes 800 widgets, sells 1,000 including the 200 inventoried from July) Direct Material Inventory OB 80,000 80,000 EB 0 Work-In-Process Inventory Finished Goods Inventory

OB 0 OB 60,000 DM 80,000 240,000 240,000 300,000 DL 120,000 COGM ($300 each) MOH(V) 40,000 EB 0 EB 0

FIXED MOH entirely expensed as a PERIOD COST regardless of level of production. Consequently with sales constant, COGS per unit and Net Income do not change with changing production levels.