Absorption and Variable Costing Chapter 8 Copyright © 2011 by The McGraw-Hill Companies, Inc. All...
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Transcript of Absorption and Variable Costing Chapter 8 Copyright © 2011 by The McGraw-Hill Companies, Inc. All...
Absorption and Variable Costing Absorption and Variable Costing
Chapter 8
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Absorption CostingAbsorption Costing
A system of accounting for costs in which both fixed and variable production costs
are considered product costs.
FixedCosts
VariableCosts
Product
8-3
Variable CostingVariable Costing
A system of cost accounting that only assigns the variable cost of production to
products.
FixedCosts
VariableCosts
Product
8-4
Absorption and Variable CostingAbsorption and Variable Costing
Absorption Costing
Variable Costing
Direct materialsDirect labor Product costs
Product costs Variable mfg. overhead
Fixed mfg. overheadPeriod costs
Period costs Selling & Admin. exp.
8-5
Absorption and Variable CostingAbsorption and Variable Costing
Absorption Costing
Variable Costing
Direct materialsDirect labor Product costs
Product costs Variable mfg. overhead
Fixed mfg. overheadPeriod costs
Period costs Selling & Admin. exp.
The difference between absorption and variable costing is the treatment of fixed manufacturing overhead.
8-6
Let’s put some numbers to an example andsee what we can learn about the differencebetween absorption and variable costing.
Absorption and Variable CostingAbsorption and Variable Costing
8-8
Mellon Co. produces a single product with the following information available:
Number of units produced annually 25,000 Variable costs per unit:
Direct materials, direct labor and variable mfg. overhead 10$ Selling & administrative expenses 3$
Fixed costs per year:Mfg. overhead 150,000$Selling & administrative expenses 100,000$
Absorption and Variable CostingAbsorption and Variable Costing
8-9
Unit product cost is determined as follows:
Absorption Costing
Variable Costing
Direct materials, direct labor, and variable mfg. overhead 10$ 10$ Fixed mfg. overhead ($150,000 ÷ 25,000 units) 6 - Unit product cost 16$ 10$
Absorption and Variable CostingAbsorption and Variable Costing
Selling and administrative expenses are always treated as period expenses and
deducted from revenue.8-10
Absorption CostingAbsorption Costing Income Statements Income Statements
Absorption CostingSales (20,000 × $30) 600,000$ Less cost of goods sold: Beginning inventory Add COGM Goods available for sale Ending inventoryGross marginLess selling & admin. exp. Variable FixedNet income
Mellon Co. had no beginning inventory, produced 25,000 units and sold 20,000 units this year at $30 each.
8-11
Absorption CostingSales (20,000 × $30) 600,000$ Less cost of goods sold: Beginning inventory -$ Add COGM (25,000 × $16) 400,000 Goods available for sale 400,000$ Ending inventory (5,000 × $16) 80,000 320,000 Gross margin 280,000$ Less selling & admin. exp. Variable FixedNet income
Absorption CostingAbsorption Costing Income Statements Income Statements
Mellon Co. had no beginning inventory, produced 25,000 units and sold 20,000 units this year at $30 each.
8-12
Absorption CostingSales (20,000 × $30) 600,000$ Less cost of goods sold: Beginning inventory -$ Add COGM (25,000 × $16) 400,000 Goods available for sale 400,000$ Ending inventory (5,000 × $16) 80,000 320,000 Gross margin 280,000$ Less selling & admin. exp. Variable (20,000 × $3) 60,000$ Fixed 100,000 160,000 Net income 120,000$
Mellon Co. had no beginning inventory, produced 25,000 units and sold 20,000 units this year at $30 each.
Absorption CostingAbsorption Costing Income Statements Income Statements
8-13
Variable Costing Variable Costing Income StatementsIncome Statements
Now let’s look at variable costing by Mellon Co.
Variable CostingSales (20,000 × $30) 600,000$ Less variable expenses: Beginning inventory -$ Add COGM Goods available for sale Ending inventory Variable cost of goods sold Variable selling & administrative expenses Contribution marginLess fixed expenses: Manufacturing overhead Selling & administrative expensesNet income
8-15
Variable Costing Variable Costing Income StatementsIncome Statements
Now let’s look at variable costing by Mellon Co.
Variable CostingSales (20,000 × $30) 600,000$ Less variable expenses: Beginning inventory -$ Add COGM (25,000 × $10) 250,000 Goods available for sale 250,000$ Ending inventory (5,000 × $10) 50,000 Variable cost of goods sold 200,000$ Variable selling & administrative expenses Contribution marginLess fixed expenses: Manufacturing overhead Selling & administrative expensesNet income
We exclude thefixed manufacturing
overhead.
8-16
Variable CostingSales (20,000 × $30) 600,000$ Less variable expenses: Beginning inventory -$ Add COGM (25,000 × $10) 250,000 Goods available for sale 250,000$ Ending inventory (5,000 × $10) 50,000 Variable cost of goods sold 200,000$ Variable selling & administrative expenses (20,000 × $3) 60,000 260,000 Contribution margin 340,000$ Less fixed expenses: Manufacturing overhead 150,000$ Selling & administrative expenses 100,000 250,000 Net income 90,000$
Variable Costing Variable Costing Income StatementsIncome Statements
Now let’s look at variable costing by Mellon Co.
8-17
Cost of Goods Sold
Ending Inventory
Period Expense Total
Absorption costing Variable mfg. costs 200,000$ Fixed mfg. costs 120,000
320,000$
Variable costing Variable mfg. costs 200,000$ Fixed mfg. costs -
200,000$
Comparing Absorption andComparing Absorption andVariable CostingVariable Costing
Let’s compare the methods.
8-18
Comparing Absorption andComparing Absorption andVariable CostingVariable Costing
Let’s compare the methods.Cost of Goods Sold
Ending Inventory
Period Expense Total
Absorption costing Variable mfg. costs 200,000$ 50,000$ -$ Fixed mfg. costs 120,000 30,000 -
320,000$ 80,000$ -$
Variable costing Variable mfg. costs 200,000$ 50,000$ -$ Fixed mfg. costs - - 150,000
200,000$ 50,000$ 150,000$
8-19
Cost of Goods Sold
Ending Inventory
Period Expense Total
Absorption costing Variable mfg. costs 200,000$ 50,000$ -$ 250,000$ Fixed mfg. costs 120,000 30,000 - 150,000
320,000$ 80,000$ -$ 400,000$
Variable costing Variable mfg. costs 200,000$ 50,000$ -$ 250,000$ Fixed mfg. costs - - 150,000 150,000
200,000$ 50,000$ 150,000$ 400,000$
Comparing Absorption andComparing Absorption andVariable CostingVariable Costing
Let’s compare the methods.
8-20
Reconciling Income Under Reconciling Income Under Absorption and Variable CostingAbsorption and Variable Costing
We can reconcile the difference between absorption and variable net income as follows:
Variable costing net income 90,000$ Add: Fixed mfg. overhead costs deferred in inventory (5,000 units × $6 per unit) 30,000 Absorption costing net income 120,000$
Fixed mfg. overhead $150,000 Units produced 25,000
= $6.00 per unit =
8-22
Cost-Volume-Profit AnalysisCost-Volume-Profit Analysis
• CVP includes all fixed costs to compute breakeven. – Variable costing and CVP are consistent as both
treat fixed costs as a lump sum.
• Absorption costing defers fixed costs into inventory.– Absorption costing is inconsistent with CVP
because absorption costing treats fixed costs on a per unit basis.
8-24
Extending the ExampleExtending the Example
Let’s look at the second
year ofoperationsfor MellonCompany.
8-26
Mellon Co. Year 2Mellon Co. Year 2
In its second year of operations, Mellon Co. started with an inventory of 5,000 units, produced 25,000 units and sold
30,000 units at $30 each.
Number of units produced annually 25,000 Variable costs per unit:
Direct materials, direct labor and variable mfg. overhead 10$ Selling & administrative expenses 3$
Fixed costs per year:Mfg. overhead 150,000$Selling & administrative expenses 100,000$
8-27
Mellon Co. Year 2Mellon Co. Year 2
Unit product cost is determined as follows:
Absorption Costing
Variable Costing
Direct materials, direct labor, and variable mfg. overhead 10$ 10$ Fixed mfg. overhead ($150,000 ÷ 25,000 units) 6 - Unit product cost 16$ 10$
There has been nochange in Mellon’s
cost structure.8-28
Mellon Co. Year 2Mellon Co. Year 2
Now let’s look at Mellon’s income statementassuming absorption costing is used.
8-29
Absorption CostingSales (30,000 × $30) 900,000$ Less cost of goods sold: Beg. inventory (5,000 x $16) 80,000$ Add COGM (25,000 × $16) 400,000 Goods available for sale 480,000$ Ending inventory - 480,000 Gross margin 420,000$ Less selling & admin. exp. Variable (30,000 × $3) 90,000$ Fixed 100,000 190,000 Net income 230,000$
Mellon Co. Year 2Mellon Co. Year 2Units in ending inventory from the previous period.
8-30
Absorption CostingSales (30,000 × $30) 900,000$ Less cost of goods sold: Beg. inventory (5,000 x $16) 80,000$ Add COGM (25,000 × $16) 400,000 Goods available for sale 480,000$ Ending inventory - 480,000 Gross margin 420,000$ Less selling & admin. exp. Variable (30,000 × $3) 90,000$ Fixed 100,000 190,000 Net income 230,000$
Mellon Co. Year 2Mellon Co. Year 2
25,000 units produced in the current period.8-31
Mellon Co. Year 2Mellon Co. Year 2
Next, we’ll look at Mellon’s income statementassuming variable costing variable costing is used.
8-32
Variable CostingSales (30,000 × $30) 900,000$ Less variable expenses: Beg. inventory (5,000 × $10) 50,000$ Add COGM (25,000 × $10) 250,000 Goods available for sale 300,000$ Ending inventory - Variable cost of goods sold 300,000$ Variable selling & administrative expenses (30,000 × $3) 90,000 390,000 Contribution margin 510,000$ Less fixed expenses: Manufacturing overhead 150,000$ Selling & administrative expenses 100,000 250,000 Net income 260,000$
Mellon Co. Year 2Mellon Co. Year 2
Excludes fixed manufacturing overhead.8-33
SummarySummary
In the first period, production (25,000 units)was greater than sales (20,000).
Income Comparison
Costing Method 1st Period 2nd Period TotalAbsorption 120,000$ 230,000$ 350,000$ Variable 90,000 260,000 350,000
In the second period, production (25,000 units)was less than sales (30,000).
8-34
SummarySummary
For the two-year period, total absorptionincome and total variable income are the same.
Income Comparison
Costing Method 1st Period 2nd Period TotalAbsorption 120,000$ 230,000$ 350,000$ Variable 90,000 260,000 350,000
8-35
Summary Comparison of Summary Comparison of Absorption (AC) and Variable Absorption (AC) and Variable
Costing (VC)Costing (VC)
This was the case in the first period when production of 25,000 units was greater than sales of 20,000 units.
Inventory increased from zero to 5,000 units and $120,000 absorption income was greater than
$90,000 variable income.8-37
Summary Comparison of Summary Comparison of Absorption (AC) and Variable Absorption (AC) and Variable
Costing (VC)Costing (VC)
In the second period sales of 30,000 units In the second period sales of 30,000 units were greater than production of 25,000.were greater than production of 25,000.
8-38
Summary Comparison of Summary Comparison of Absorption (AC) and Variable Absorption (AC) and Variable
Costing (VC)Costing (VC)
Inventory decreased from 5,000 units to zero,and $230,000 absorption income was less
than $260,000 variable income.8-39
Production versus Sales
Total Inventory
Effect Period Expense Effect Profit Effect
Fixed mfg. Fixed mfg.Produced > Sold Increase costs expensed < costs expensed AC > VC
AC VC
Fixed mfg. Fixed mfg.Produced < Sold Decrease costs expensed > costs expensed AC < VC
AC VC
Fixed mfg. Fixed mfg.Produced = Sold No change costs expensed = costs expensed AC = VC
AC VC
Summary Comparison of Summary Comparison of Absorption (AC) and Variable Absorption (AC) and Variable
Costing (VC)Costing (VC)
For the two-year period, units produced equals units sold, so total absorption income
equals total variable income.
8-40
Advantages
Management finds it Management finds it easy to understand.easy to understand.
Consistent withConsistent withCVP analysis.CVP analysis.
Emphasizes contribution inEmphasizes contribution in short-run pricing decisions. short-run pricing decisions.
Profit for period notProfit for period notaffected by changesaffected by changes
in fixed mfg. overhead.in fixed mfg. overhead.
Impact of fixedImpact of fixedcosts on profitscosts on profitsemphasized.emphasized.
Evaluation of Variable CostingEvaluation of Variable Costing
8-41
AdvantagesConsistent with long-runConsistent with long-run
pricing decisions that mustpricing decisions that mustcover full cost.cover full cost.
External reportingExternal reportingand income tax lawand income tax law
require absorption costingrequire absorption costing..
Evaluation of Absorption CostingEvaluation of Absorption Costing
Fixed manufacturing overhead isFixed manufacturing overhead istreated the same as the other producttreated the same as the other productcosts, direct material and direct labor.costs, direct material and direct labor.
8-42
Impact of JIT Inventory MethodsImpact of JIT Inventory Methods
In a JIT inventory system . .In a JIT inventory system . . . .
Production tendsProduction tendsto equal sales . . .to equal sales . . .
So, the difference between variable andSo, the difference between variable andabsorption income tends to disappear.absorption income tends to disappear.
8-43
Throughput CostingThroughput Costing
Example
In an automated process direct material may bethe only unit-level cost and so is the only product cost.
All other manufacturing costs are expensed as period costs.
Incentive to overproduceis reduced
Average unit cost doesnot vary with changesin production levels.
Advantages
8-45
Throughput Income StatementThroughput Income StatementSales Revenue $600,000
Throughput cost of goods sold (dir. mat.) 150,000
Gross Margin $450,000
Less: Operating costs
Direct labor 100,000
Variable mfg overhead 60,000
Fixed mfg overhead 150,000
Variable sales & admin costs 50,000
Fixed sales & admin costs 125,000
Total operating costs 375,000
Net Income $ 75,000
8-47