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Variable Costing: A Tool For Management: Mcgraw Hill/Irwin
Variable Costing: A Tool For Management: Mcgraw Hill/Irwin
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
7-2
Learning Objective 1
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
7-3
Overview of Absorption
and Variable Costing
Absorption
Costing
Variable
Costing
Direct Materials
Product
Costs
Product
Costs
Direct Labor
Variable Manufacturing Overhead
Fixed Manufacturing Overhead
Period
Costs
McGrawHill/Irwin
Period
Costs
Copyright2008,TheMcGrawHillCompanies,Inc.
7-4
Quick Check
Which
Which method
method will
will produce
produce the
the highest
highest values
values for
for
work
work in
in process
process and
and finished
finished goods
goods inventories?
inventories?
a.
a. Absorption
Absorption costing.
costing.
b.
b. Variable
Variable costing.
costing.
c.
c. They
They produce
produce the
the same
same values
values for
for these
these
inventories.
inventories.
d.
d. ItIt depends.
depends. .. ..
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
7-5
Quick Check
Which
Which method
method will
will produce
produce the
the highest
highest values
values for
for
work
work in
in process
process and
and finished
finished goods
goods inventories?
inventories?
a.
a. Absorption
Absorption costing.
costing.
b.
b. Variable
Variable costing.
costing.
c.
c. They
They produce
produce the
the same
same values
values for
for these
these
inventories.
inventories.
d.
d. ItIt depends.
depends. .. ..
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
7-6
$$
$$
Fixed
Fixed costs
costsper
per year:
year:
Manufacturing
Manufacturing overhead
overhead
Selling
Selling &&administrative
administrative expenses
expenses
$$150,000
150,000
$$100,000
100,000
McGrawHill/Irwin
25,000
25,000
10
10
33
Copyright2008,TheMcGrawHillCompanies,Inc.
7-7
Direct
Directmaterials,
materials, direct
directlabor,
labor,
and
and variable
variable mfg.
mfg. overhead
overhead
Fixed
Fixed mfg.
mfg. overhead
overhead
($150,000
($150,00025,000
25,000units)
units)
Unit
Unitproduct
productcost
cost
Absorption
Absorption
Costing
Costing
Variable
Variable
Costing
Costing
$$
10
10
$$
10
10
$$
66
16
16
$$
-10
10
Copyright2008,TheMcGrawHillCompanies,Inc.
7-8
Learning Objective 2
Prepare income
statements using both
variable and absorption
costing.
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
7-9
Income Comparison of
Absorption and Variable Costing
Lets assume the following additional
information for Harvey Company.
20,000 units were sold during the year at a price of
$30 each.
There were no units in beginning inventory.
Copyright2008,TheMcGrawHillCompanies,Inc.
7-10
Absorption Costing
Sales
Sales(20,000
(20,000$30)
$30)
Less
Lesscost
costof
ofgoods
goodssold:
sold:
Beginning
Beginninginventory
inventory
Add
AddCOGM
COGM(25,000
(25,000 $16)
$16)
Goods
Goodsavailable
available for
forsale
sale
Ending
Endinginventory
inventory(5,000
(5,000 $16)
$16)
Gross
Grossmargin
margin
Less
Lessselling
selling&&admin.
admin.exp.
exp.
Variable
Variable (20,000
(20,000$3)
$3)
Fixed
Fixed
Net
Netoperating
operatingincome
income
McGrawHill/Irwin
Absorption
AbsorptionCosting
Costing
$$600,000
600,000
$$
-400,000
400,000
400,000
400,000
80,000
80,000
$$ 60,000
60,000
100,000
100,000
320,000
320,000
280,000
280,000
160,000
160,000
$$120,000
120,000
Copyright2008,TheMcGrawHillCompanies,Inc.
7-11
Variable Costing
Variable
manufacturing
Variable
VariableCosting
Costing
costs only.
Sales
Sales(20,000
(20,000$30)
$30)
Less
Lessvariable
variableexpenses:
expenses:
Beginning
$$
-Beginninginventory
inventory
Add
250,000
AddCOGM
COGM(25,000
(25,000$10)
$10)
250,000
Goods
250,000
Goodsavailable
availablefor
forsale
sale
250,000
Less
Lessending
endinginventory
inventory(5,000
(5,000$10)
$10) 50,000
50,000
Variable
200,000
Variablecost
costof
ofgoods
goodssold
sold
200,000
Variable
Variableselling
selling&&administrative
administrative
expenses
60,000
expenses(20,000
(20,000$3)
$3)
60,000
Contribution
Contributionmargin
margin
Less
Lessfixed
fixedexpenses:
expenses:
Manufacturing
$$150,000
Manufacturingoverhead
overhead
150,000
Selling
Selling&&administrative
administrativeexpenses
expenses 100,000
100,000
Net
Netoperating
operatingincome
income
McGrawHill/Irwin
$$600,000
600,000
All fixed
manufacturing
overhead is
expensed.
260,000
260,000
340,000
340,000
250,000
250,000
$$ 90,000
90,000
Copyright2008,TheMcGrawHillCompanies,Inc.
7-12
Learning Objective 3
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
7-13
Cost
Costof
of
Goods
Goods
Sold
Sold
Absorption
Absorptioncosting
costing
Variable
Variable mfg.
mfg.costs
costs $$200,000
200,000
Fixed
120,000
Fixedmfg.
mfg.costs
costs
120,000
$$320,000
320,000
Variable
Variable costing
costing
Variable
Variable mfg.
mfg.costs
costs $$200,000
200,000
Fixed
-Fixedmfg.
mfg.costs
costs
$$200,000
200,000
McGrawHill/Irwin
Ending
Ending
Inventory
Inventory
Period
Period
Expense
Expense
$$ 50,000
50,000
30,000
30,000
$$ 80,000
80,000
$$
$$ 50,000
50,000
-$$ 50,000
50,000
$$
-150,000
150,000
$$150,000
150,000
$$
----
Total
Total
$$250,000
250,000
150,000
150,000
$$400,000
400,000
$$250,000
250,000
150,000
150,000
$$400,000
400,000
Copyright2008,TheMcGrawHillCompanies,Inc.
7-14
$$
90,000
90,000
30,000
30,000
$$ 120,000
120,000
Copyright2008,TheMcGrawHillCompanies,Inc.
7-15
McGrawHill/Irwin
25,000
25,000
30,000
30,000
5,000
5,000
$$
30
30
$$
10
10
$$
33
$$150,000
150,000
$$100,000
100,000
Copyright2008,TheMcGrawHillCompanies,Inc.
7-16
Direct
Directmaterials,
materials, direct
directlabor,
labor,
and
and variable
variable mfg.
mfg. overhead
overhead
Fixed
Fixed mfg.
mfg. overhead
overhead
($150,000
($150,00025,000
25,000units)
units)
Unit
Unitproduct
productcost
cost
Absorption
Absorption
Costing
Costing
Variable
Variable
Costing
Costing
$$
10
10
$$
10
10
$$
66
16
16
$$
-10
10
Copyright2008,TheMcGrawHillCompanies,Inc.
7-17
Absorption Costing
Sales
Sales(30,000
(30,000 $30)
$30)
Less
Lesscost
costof
ofgoods
goodssold:
sold:
Beg.
Beg. inventory
inventory(5,000
(5,000 $16)
$16)
Add
AddCOGM
COGM (25,000
(25,000 $16)
$16)
Goods
Goodsavailable
available for
forsale
sale
Less
Lessending
endinginventory
inventory
Gross
Grossmargin
margin
Less
Lessselling
selling &&admin.
admin. exp.
exp.
Variable
Variable (30,000
(30,000 $3)
$3)
Fixed
Fixed
Net
Netoperating
operatingincome
income
Absorption
AbsorptionCosting
Costing
$$900,000
900,000
$$ 80,000
80,000
400,000
400,000
480,000
480,000
-$$ 90,000
90,000
100,000
100,000
480,000
480,000
420,000
420,000
190,000
190,000
$$230,000
230,000
Copyright2008,TheMcGrawHillCompanies,Inc.
7-18
Variable Costing
Variable
manufacturing
costs only. Variable Costing
Variable Costing
Sales
$$900,000
Sales(30,000
(30,000 $30)
$30)
900,000
Less
Lessvariable
variable expenses:
expenses:
Beg.
$$ 50,000
Beg. inventory
inventory(5,000
(5,000 $10)
$10)
50,000
Add
250,000
AddCOGM
COGM(25,000
(25,000 $10)
$10)
250,000
All fixed
Goods
300,000
Goodsavailable
available for
forsale
sale
300,000
manufacturing
Less
-Lessending
endinginventory
inventory
overhead is
Variable
cost
of
goods
sold
300,000
Variable cost of goods sold
300,000
expensed.
Variable
Variable selling
selling&&administrative
administrative
expenses
90,000
390,000
expenses(30,000
(30,000 $3)
$3)
90,000
390,000
Contribution
510,000
Contributionmargin
margin
510,000
Less
Lessfixed
fixedexpenses:
expenses:
Manufacturing
$$150,000
Manufacturingoverhead
overhead
150,000
Selling
250,000
Selling&&administrative
administrative expenses
expenses 100,000
100,000
250,000
Net
$$260,000
Netoperating
operatingincome
income
260,000
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
7-19
Copyright2008,TheMcGrawHillCompanies,Inc.
7-20
Costing Method
Absorption
Variable
McGrawHill/Irwin
1st Period
$ 120,000
90,000
2nd Period
$ 230,000
260,000
Total
$ 350,000
350,000
Copyright2008,TheMcGrawHillCompanies,Inc.
7-21
Effect
on
iniventory
Inventory
increases
Inventory
decreases
Production = Sales
No change
McGrawHill/Irwin
Relation between
variable and
absorption income
Absorption
>
Variable
Absorption
<
Variable
Absorption
=
Variable
Copyright2008,TheMcGrawHillCompanies,Inc.
7-22
Copyright2008,TheMcGrawHillCompanies,Inc.
7-23
McGrawHill/Irwin
30,000
30,000
25,000
25,000
$$
30
30
$$
10
10
$$
33
$$150,000
150,000
$$100,000
100,000
Copyright2008,TheMcGrawHillCompanies,Inc.
7-24
Direct
Directmaterials,
materials, direct
directlabor,
labor,
and
and variable
variable mfg.
mfg. overhead
overhead
Fixed
Fixed mfg.
mfg. overhead
overhead
($150,000
($150,00030,000
30,000units)
units)
Unit
Unitproduct
productcost
cost
Absorption
Absorption
Costing
Costing
Variable
Variable
Costing
Costing
$$
10
10
$$
10
10
$$
55
15
15
$$
-10
10
Since
Since the
the number
number of
of units
units produced
produced increased
increased
in
in this
this example,
example, while
while the
the fixed
fixed manufacturing
manufacturing overhead
overhead
remained
remained the
the same,
same, the
the absorption
absorption unit
unit cost
cost is
is less.
less.
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
7-25
Sales
Sales(25,000
(25,000$30)
$30)
Less
Lesscost
costof
ofgoods
goodssold:
sold:
Beginning
Beginninginventory
inventory
Add
AddCOGM
COGM(30,000
(30,000 $15)
$15)
Goods
Goodsavailable
available for
forsale
sale
Ending
Endinginventory
inventory(5,000
(5,000 $15)
$15)
Gross
Grossmargin
margin
Less
Lessselling
selling&&admin.
admin.exp.
exp.
Variable
Variable (25,000
(25,000$3)
$3)
Fixed
Fixed
Net
Netoperating
operatingincome
income
McGrawHill/Irwin
Absorption
AbsorptionCosting
Costing
$$750,000
750,000
$$
-450,000
450,000
450,000
450,000
75,000
75,000
$$ 75,000
75,000
100,000
100,000
375,000
375,000
375,000
375,000
175,000
175,000
$$200,000
200,000
Copyright2008,TheMcGrawHillCompanies,Inc.
7-26
Sales
Sales(25,000
(25,000$30)
$30)
Less
Lessvariable
variableexpenses:
expenses:
Beginning
$$
-Beginninginventory
inventory
Add
300,000
AddCOGM
COGM(30,000
(30,000$10)
$10)
300,000
Goods
300,000
Goodsavailable
availablefor
forsale
sale
300,000
Less
Lessending
endinginventory
inventory(5,000
(5,000$10)
$10) 50,000
50,000
Variable
250,000
Variablecost
costof
ofgoods
goodssold
sold
250,000
Variable
Variableselling
selling&&administrative
administrative
expenses
75,000
expenses(25,000
(25,000$3)
$3)
75,000
Contribution
Contributionmargin
margin
Less
Lessfixed
fixedexpenses:
expenses:
Manufacturing
$$150,000
Manufacturingoverhead
overhead
150,000
Selling
Selling&&administrative
administrativeexpenses
expenses 100,000
100,000
Net
Netoperating
operatingincome
income
McGrawHill/Irwin
$$750,000
750,000
All fixed
manufacturing
overhead is
expensed.
325,000
325,000
425,000
425,000
250,000
250,000
$$175,000
175,000
Copyright2008,TheMcGrawHillCompanies,Inc.
7-27
McGrawHill/Irwin
20,000
20,000
25,000
25,000
5,000
5,000
$$
30
30
$$
10
10
$$
33
$$150,000
150,000
$$100,000
100,000
Copyright2008,TheMcGrawHillCompanies,Inc.
7-28
Direct
Directmaterials,
materials, direct
directlabor,
labor,
and
and variable
variable mfg.
mfg. overhead
overhead
Fixed
Fixed mfg.
mfg. overhead
overhead
($150,000
($150,00020,000
20,000units)
units)
Unit
Unitproduct
productcost
cost
Absorption
Absorption
Costing
Costing
Variable
Variable
Costing
Costing
$$
10
10
$$
10
10
$$
7.50
7.50
17.50
17.50
$$
-10
10
Since
Since the
the number
number of
of units
units produced
produced decreased
decreased in
in the
the
second
second year,
year, while
while the
the fixed
fixed manufacturing
manufacturing overhead
overhead
remained
remained the
the same,
same, the
the absorption
absorption unit
unit cost
cost is
is now
now higher.
higher.
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
7-29
Sales
Sales(25,000
(25,000 $30)
$30)
Less
Lesscost
costof
ofgoods
goodssold:
sold:
Beg.
Beg. inventory
inventory(5,000
(5,000 $15)
$15)
Add
Add COGM
COGM (20,000
(20,000 $17.50)
$17.50)
Goods
Goodsavailable
available for
forsale
sale
Less
Lessending
endinginventory
inventory
Gross
Grossmargin
margin
Less
Lessselling
selling &&admin.
admin. exp.
exp.
Variable
Variable (25,000
(25,000 $3)
$3)
Fixed
Fixed
Net
Netoperating
operatingincome
income
Absorption
AbsorptionCosting
Costing
$$750,000
750,000
$$ 75,000
75,000
350,000
350,000
425,000
425,000
--
$$ 75,000
75,000
100,000
100,000
425,000
425,000
325,000
325,000
175,000
175,000
$$150,000
150,000
Copyright2008,TheMcGrawHillCompanies,Inc.
7-30
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
7-31
Costing Method
Absorption
Variable
Year One
$ 200,000
175,000
Year Two
$ 150,000
175,000
Total
$ 350,000
350,000
Conclusions
Net operating income is not affected by changes in
production using variable costing.
Net operating income is affected by changes in production
using absorption costing even though the number of units
sold is the same each year.
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
7-32
Learning Objective 4
Understand the
advantages and
disadvantages of both
variable and absorption
costing.
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
7-33
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
7-34
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
7-35
To
Toconform
conform to
to
GAAP
GAAPrequirements,
requirements,
absorption
absorptioncosting
costing must
mustbe
be used
usedfor
for
external
externalfinancial
financialreports
reportsin
inthe
the
United
UnitedStates.
States.
Under
Underthe
theTax
Tax
Reform
ReformAct
Actof
of1986,
1986,
absorption
absorption costing
costing must
must be
be
used
when
filing
income
used
when
filing
income
Since
Sincetop
topexecutives
executives
tax
taxreturns.
returns.
are
usually
evaluated
based
on
are usually evaluated based on
external
externalreports
reportsto
toshareholders,
shareholders,
they
theymay
mayfeel
feelthat
thatdecisions
decisions
should
shouldbe
bebased
basedon
on
absorption
absorptioncost
cost income.
income.
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
7-36
Management finds
it more useful.
Advantages
Impact of fixed
costs on profits
emphasized.
McGrawHill/Irwin
Consistent with
CVP analysis.
Net operating income
is closer to
net cash flow.
Consistent with standard
costs and flexible budgeting.
Easier to estimate profitability
of products and segments.
Profit is not affected by
changes in inventories.
Copyright2008,TheMcGrawHillCompanies,Inc.
7-37
Absorption
Costing
McGrawHill/Irwin
Fixed manufacturing
costs are capacity costs
and will be incurred
even if nothing is
produced.
Variable
Costing
Copyright2008,TheMcGrawHillCompanies,Inc.
7-38
Companies
Companies involved
involved in
in TOC
TOC use
use aa form
form of
of variable
variable
costing.
costing. However,
However,one
one difference
difference of
of the
the TOC
TOC approach
approach
isis that
that itit treats
treats direct
direct labor
labor as
as aa fixed
fixed cost
cost for
for three
three
reasons:
reasons:
Many
Manycompanies
companieshave
haveaacommitment
commitmentto
toguarantee
guarantee
workers
workersaaminimum
minimum number
number of
ofpaid
paidhours.
hours.
Direct
Direct labor
labor isisusually
usuallynot
not the
the constraint.
constraint.
TOC
TOCemphasizes
emphasizesthe
therole
roledirect
directlaborers
laborersplay
playin
indriving
driving
continuous
continuous improvement.
improvement. Since
Sincelayoffs
layoffsoften
oftendevastate
devastate
morale,
morale,managers
managersinvolved
involvedin
inTOC
TOCare
areextremely
extremely
reluctant
reluctant to
tolay
layoff
offemployees.
employees.
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
7-39
Copyright2008,TheMcGrawHillCompanies,Inc.
7-40
McGrawHill/Irwin
End of Chapter 7
Copyright2008,TheMcGrawHillCompanies,Inc.