1

Variable Variable Costing for Costing for

Management Management AnalysisAnalysis

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2

Absorption Costing

Under absorption costing, all manufacturing costs are

included in finished goods and remain there as an asset until

the goods are sold.

20-1

37

20-1

4

Absorption costing is necessary in determining

historical costs for financial reporting to external users

and for tax reporting.

20-1

5

Variable costing (also called direct costing) may be more

useful to management in making decisions. In variable

costing, the cost of goods manufactured is composed only of variable manufacturing costs.

Variable Costing 20-1

610

20-1

7

Variable Costing

Absorption Costing

Cost of Goods ManufacturedCost of Goods Manufactured

Cost of Goods ManufacturedCost of Goods Manufactured

DirectDirectMaterialsMaterials

DirectDirectLaborLabor

VariableVariableFactory OHFactory OH

FixedFixedFactory OHFactory OH

Period ExpensePeriod Expense

Costs of Goods Manufactured Comparison

11

20-1

812

Variable Costing Income Statement Compared to Absorption Costing Income Statement

Assume that Belling Co. manufactured 15,000 units at the following costs:

20-1

913

20-1Variable Costing Income Statement

1016

20-1Absorption Costing Income Statement

11

The absorption costing income statement does not distinguish between

variable and fixed costs. All manufacturing costs are included in the

cost of good sold. Deducting cost of goods sold from sales yields gross

profit. Deducting selling and administrative expenses then yields

income from operations.

20-1

12

Example Exercise 20-1

Leone Company has the following information for March:

Determine the March (a) manufacturing margin, (b) contribution margin, and (c) income from operations for Leone Company.

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Sales $450,000Variable cost of goods sold 220,000Fixed manufacturing costs 80,000Variable selling and administrative expenses 50,000Fixed selling and administrative expenses 35,000

20-1

13

Follow My Example 20-1

For Practice: PE 20-1A, PE 20-1B

(a) $230,000 ($450,000 – $220,000)

(b)$180,000 ($230,000 – $50,000)

(c) $65,000 ($180,000 – $80,000 – $35,000)

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20-1

14

Frand Manufacturing Company has no beginning

inventory and sales are estimated to be 20,000 units at

$75 per unit, regardless of production levels.

20-2

15

Proposal 1: 20,000 Units to be Manufactured and Sold

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20-2

1641

Proposal 2: 25,000 Units to be Manufactured; 20,000 Units to be Sold

20-2

1742

20-2Absorption Costing Income Statements for Two Production Levels

$35V 20F$55

1843

20-2

43

20-2Absorption Costing Income Statements for Two Production Levels

$35V 16F$51

19

20-2

The $80,000 increase in income from operations would

be caused by allocating the fixed manufacturing costs of

$400,000 over a greater number of units of production.

20

Now, assume that Frand Manufacturing uses variable

costing and has sales of 20,000 units. Exhibit 6 illustrates that net

income remains a constant $200,000 at the three levels of

production.

20-2

2146

20-2Variable Costing Income Statements for Two Production Levels

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Example Exercise 20-4

Variable costs are $100 per unit, and fixed costs are $50,000. Sales are estimated to be 4,000 units. (a) How much would absorption costing income from operations differ between a plan to produce 4,000 units and a plan to produce 5,000 units? (b) How much would variable costing income from operations differ between the two production plans?

47

20-2

23

Follow My Example 20-4

For Practice: PE 20-4A, PE 20-4B

(a) $10,000 greater in producing 5,000 units 4,000 units x ($12.50 – $10.00), or [1,000 units x ($50,000/5,000 units)].

(b) There would be no difference in variable costing income from operations between the two plans.

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20-2

24

Describe and illustrate management’s use of variable

costing and absorption costing for controlling costs, pricing products,

planning production, analyzing contribution margins, and

analyzing market segments.

Objective 3Objective 3Objective 3Objective 3

20-3

25

Controllable and Noncontrollable Costs

For a specific level of management, controllable costs are costs that can be influenced

by management at that level, and noncontrollable costs are

costs that another level of management controls.

20-3

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Pricing Products

Many factors enter into determining the selling price of a product. The cost of making the product is clearly significant. In the short run, pricing decisions

should be based upon making the best use of existing manufacturing

facilities.

20-3

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In the long run, plant capacity can be increased or decreased. If a

business is to continue operating, the selling prices of its products

must cover all costs and provide a reasonable income.

20-3

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Analyzing Contribution Margins

Managers can plan and control operations by

evaluating the differences between planned and actual

contribution margin.

20-3

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Analyzing Market Segments

A market segment is a portion of a business that

can be analyzed using sales, costs, and expenses

to determine its profitability.

20-3

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Use variable costing for analyzing market

segments including product, territories, and salespersons segments.

Objective 4Objective 4Objective 4Objective 4

20-4

31

Camelot Fragrance Company manufactures and sells the

Gwenevere perfume for women and the Lancelot cologne line for men.

The inventories are negligible.

Analyzing Market Segments 20-4

3258

20-4Camelot Fragrance Company

3360

20-4Contribution Margin by Sales Territory Report

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Sales mix, sometimes referred to as product mix, is defined as the relative distribution of

sales among the various products sold.

Sales Mix 20-4

35

Product Profitability Analysis

Some products are more profitable than others due to differences with respect to

pricing, manufacturing costs, advertising support, or salesperson

support. Exhibit 9 shows the contribution margin by product for

Camelot Fragrance Company.

20-4

3664

20-4Contribution Margin by Product Line Report

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Salesperson Profitability Analysis

Sales managers may wish to evaluate the performance of salespersons.

This may be done with a report that shows contribution margin by

salesperson. Such a report is shown in Exhibit 10 for the Northern

Territory salespersons.

20-4

38

20-4Contribution Margin by Salesperson Report

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3966

Example Exercise 20-5

The following data are for Moss Creek Apparel:

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East WestSales volume (units):

Shirts 6,000 5,000Shorts 4,000 8,000

Sales price:Shirts $ 12 $ 13Shorts $ 16 $ 18

Variable cost per unit:Shirts $ 7 $ 7Shorts $ 10 $ 10

Determine the contribution margin for (a) Shorts and (b) the West Region.

20-4

40

Follow My Example 20-5

For Practice: PE 20-5A, PE 20-5B

(a) $88,000 [4,000 units x ($16 – $10)] + [8,000 units x ($18 – $10)]

(b) $94,000 [5,000 units x ($13 – $7)] + [8,000 units x ($18 – $10)]

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20-4