Chapter 4: Variable Costing and Segment Reporting

Variable costing: The costing method under which manufacturing costs vary with output are
treated as product costs including direct materials, variable overhead and ordinarily direct
labor but fixed manufacturing overhead is treated as a period cost and is expensed on the
income statement as incurred.

Absorption costing: The costing method under which all types of manufacturing costs vary
with output are treated as product costs including direct materials, variable overhead and
ordinarily direct labor but fixed manufacturing overhead is treated as a product cost and is
expensed on the income statement as incurred.

Traceable fixed cost: The fixed cost that is incurred for the existence of a segment- if the
segment had never existed, the fixed cost would not have been incurred and if the segment
were eliminated, the fixed cost would disappear. For example, the salary of a particular
product’s manager, the maintenance cost of a building used for manufacturing a particular
product.

Common fixed cost: The fixed cost that supports the operations of more than one segment,
but is not traceable in whole or part to any one segment. Even if a segment were entirely
eliminated, there would be no change in a true common fixed cost. For example, the salary of
the CEO of General Motors and the cost of the receptionist’s salary.

Example 1: Given, selling price of a product is Tk.100000 per unit, per unit direct materials
cost is Tk.19000, direct labor cost is Tk.5000 and variable manufacturing overhead cost is
Tk.1000. Fixed manufacturing overhead is Tk.70000 per month, variable selling and
administrative expense is Tk.10000 per unit and fixed selling and administrative expense is
Tk.20000 per month. Other information is:
January February March
Beginning inventory 0 0 1
Units produced 1 2 4
Units sold 1 1 5
Ending inventory 0 1 0

Prepare variable costing income statement and absorption costing income statement.

Solution:
Variable cost per unit is Tk. (19000+5000+1000) = Tk.25000
Variable costing income statement
January February March
Sales revenue (100000X1, 1, 5) 100000 100000 500000
(-) variable cost of goods sold (25000X1,1,5) 25000 25000 125000
(-) Variable selling and admin exp. (10000X1,1,5) 10000 10000 50000
Contribution margin 65000 65000 325000
(-) Fixed manufacturing cost 70000 70000 70000
(-) Fixed selling and admin expense 20000 20000 20000
Net operating income (25000) (25000) 235000

1
Absorption costing per unit product cost:
January February March
Direct materials cost 19000 19000 19000
Direct labor cost 5000 5000 5000
Variable manufacturing overhead cost 1000 1000 1000
Fixed manufacturing overhead (70000/1,2,4) 70000 35000 17500
Per unit total cost 95000 60000 42500

Absorption costing income statement

January February March
Sales revenue (100000X1,1,5) 100000 100000 500000
(-) Cost of goods sold (95000X1 for January, 60000X1
For February and 60000X1+42500X4 for March) 95000 60000 230000
Gross margin 5000 40000 270000
(-) Selling and admin expense (variable+fixed) 30000 30000 70000
Net operating income (25000) 10000 200000

Problem 2: Sales revenue of Maxim Ltd. is Tk.500000, variable cost is Tk.230000, traceable
fixed cost is Tk.171000, common fixed cost is Tk.85500. It assumes that 60% sales earn from
business products and 40% sales comes from customer products. Traceable fixed cost of
business products is Tk.90000 and of customer products is Tk.81000. Variable cost of
business products is Tk.150000 and of customer products is Tk.80000. Determine break-even
point sales for overall company, business products and customer products (segment
breakeven).
Problem 3: Given (Tk.)
Selling price per unit 50
Direct materials cost per unit 11
Direct labor cost per unit 6
Variable manufacturing overhead per unit 3
Fixed manufacturing overhead 120000
Variable selling and administrative cost per unit 4
Fixed selling and administrative cost 70000
Year 1 Year 2
Beginning inventory 0 2000
Units produced 10000 6000
Units sold 8000 8000
Ending inventory 2000 0
a) Compute unit product cost for each year and prepare income statement under absorption
costing.
b) Compute unit product cost for each year and prepare income statement under variable
costing.
Problem 4: Given (Tk.),
Company total Service G Service H
Service revenue 1000000 400000 600000
(-) Variable expenses 220000 100000 120000
Contribution margin 780000 300000 480000
(-) Traceable fixed cost 670000 280000 390000
Segment margin 110000 20000 90000
(-) Common fixed cost 60000 24000 36000

2
Net operating income 50000 (4000) 54000

a) Prepare segment income statement correctly and comment on dropping of service G.

b) The company plans to go for advertisement for Tk.20000 that may increase service
revenue Tk.100000 without affecting fixed cost. Estimate the effect of this plan on segment
margin and company margin.
c) Determine break-even point revenue for company and two services.