Chapter 4 Profit Reporting for Management Analysis Managerial Accounting 8th Edition Warren Reeve...

Chapter 4Chapter 4Profit Reporting for Profit Reporting for

Management AnalysisManagement AnalysisManagerial Accounting

8th Edition

Warren Reeve Fess

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1. Describe and illustrate income reporting under variable costing and absorption costing.

2. Describe and illustrate income analysis under variable costing and absorption costing.

3. Describe and illustrate management’s use of variable costing and absorption costing for controlling costs, pricing products, planning production, analyzing market segments, and analyzing contribution margins.

ObjectivesObjectivesObjectivesObjectives

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

After studying this After studying this chapter, you should chapter, you should

be able to:be able to:

ObjectivesObjectivesObjectivesObjectives

4. Illustrate contribution margin reporting for products, territories, and salespersons.

5. Explain changes in contribution margin as a result of quantity and price factors.

6. Describe and illustrate contribution margin reporting and analysis for service firms.

Two Costing MethodsTwo Costing Methods

Used for external financial reporting

Includes direct materials, direct labor, variable factory overhead, and fixed factory overhead as part of total product cost

Absorption CostingAbsorption Costing

Two Costing MethodsTwo Costing Methods

Variable CostingVariable Costing Used for internal planning and decision

making Does not include fixed factory overhead

as a product cost

Absorption Costing Compared to Absorption Costing Compared to Variable CostingVariable Costing

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

Variable Costing Income StatementSales (15,000 x $50) $750,000Variable cost of goods sold:

Variable cost of goods mfg.(15,000 x $25) $375,000

Less ending inventory 0Variable cost of goods sold 375,000

Manufacturing margin $375,000Variable selling and administrative

expenses (15,000 x $5) 75,000Contribution margin $300,000Fixed costs:

Fixed manufacturing costs $150,000Fixed selling and administrative

expenses 50,000 200,000Income from operations $100,000

Units Manufactured Equal Units SoldUnits Manufactured Equal Units Sold

Sales (15,000 x $50) $750,000Cost of goods sold: Cost of goods manufactured

(15,000 x $35) $525,000Less ending inventory 0Cost of goods sold 525,000

Gross profit $225,000Selling and administrative expenses

($75,000 + $50,000) 125,000Income from operations $100,000

Sales (15,000 x $50) $750,000Cost of goods sold: Cost of goods manufactured

(15,000 x $35) $525,000Less ending inventory 0Cost of goods sold 525,000


($75,000 + $50,000) 125,000Income from operations $100,000 Income from operations $100,000

Absorption Costing Income Statement

Units Manufactured Equal Units SoldUnits Manufactured Equal Units Sold

When the number of units manufactured equals the number of units sold, income from operations will be

the same under both methods.

Variable Costing Income Statement

Sales (12,000 x $50) $600,000Variable cost of goods sold:

Variable cost of goods manufactured (15,000 x $25) $375,000

Less ending inventory (3,000 x $25) 75,000 Variable cost of goods sold 300,000

Manufacturing margin $300,000Variable selling and admin. expenses 60,000Contribution margin $240,000Fixed costs:

Fixed manufacturing costs $150,000Fixed selling and admin. expenses 50,000 200,000

Income from operations $ 40,000

Units Manufactured Exceed Units SoldUnits Manufactured Exceed Units Sold

Absorption Costing Income StatementSales (12,000 x $50) $600,000Cost of goods sold:

Cost of goods manufactured (15,000 x $35) $525,000

Less ending inventory (3,000 x $35) 105,000 Cost of goods sold 420,000

Gross profit $180,000Selling and administrative expenses [(12,000 x $5) + $50,000] 110,000Income from operations $ 70,000


Operating Income:Absorption costing $70,000Variable costing 40,000 Difference $30,000


Why is absorption costing income higher when units manufactured exceed units sold?

Why is absorption costing income higher when units manufactured exceed units sold?

Analysis:Units manufactured 15,000Units sold 12,000Ending inventory units 3,000Fixed cost per unit x $10 Difference $30,000


Operating Income:Absorption costing $70,000Variable costing 40,000 Difference $30,000

Sales (15,000 x $50) $750,000Variable cost of goods sold:

Beginning inventory (5,000 x $25) $125,000Variable cost of goods manufactured

(10,000 x $25) 250,000 375,000Manufacturing margin $375,000Variable selling and admin. expenses 75,000Contribution margin $300,000Fixed costs:

Fixed manufacturing costs $150,000Fixed selling and admin. expenses 50,000 200,000

Income from operations $100,000

Units Manufactured Are Less Than Units SoldUnits Manufactured Are Less Than Units SoldVariable Costing Income Statement

Sales (15,000 x $50) $750,000Cost of goods sold:

Beginning inventory (5,000 x $35) $175,000Cost of good manufactured

(10,000 x $45) 400,000Cost of goods sold 575,000


($75,000 + $50,000) 125,000Income from operations $ 50,000

Absorption Costing Income StatementUnits Manufactured Are Less Than Units SoldUnits Manufactured Are Less Than Units Sold

Operating Income:Variable costing $100,000Absorption costing 50,000 Difference $ 50,000

Units Manufactured Are Less Than Units SoldUnits Manufactured Are Less Than Units Sold

Why is variable costing income higher when units manufactured are

less than units sold?

Why is variable costing income higher when units manufactured are

less than units sold?

Units Manufactured Are Less Than Units SoldUnits Manufactured Are Less Than Units Sold

Analysis:Units sold 15,000Units manufactured 10,000Ending inventory units 5,000Fixed cost per unit x $10 Difference $50,000

Operating Income:Variable costing $100,000Absorption costing 50,000 Difference $ 50,000

IFIF Units Sold < Units produced

THENTHEN Variable Costing < Absorption CostingIncome Income

IFIF Units Sold > Units produced

THENTHEN Variable Costing > Absorption CostingIncome Income

Income Analysis Under Variable Income Analysis Under Variable Costing and Absorption CostingCosting and Absorption Costing


Frand Manufacturing Company has no beginning

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

$75 per unit, regardless of production levels.

Frand Manufacturing Company has no beginning

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

$75 per unit, regardless of production levels.



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

Total Cost Unit CostManufacturing costs:

Variable $ 700,000 $35Fixed 400,000 20 Total costs $1,100,000 $55

Selling and administrative exp.Variable ($5 per unit sold) $ 100,000Fixed 100,000 Total expenses $ 200,000



Total Cost Unit CostManufacturing costs:

Variable $ 875,000 $35Fixed 400,000 16 Total costs $1,275,000 $51

Selling and administrative exp.Variable ($5 per unit sold) $ 100,000Fixed 100,000 Total expenses $ 200,000

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

Frand Manufacturing CompanyAbsorption Costing Income Statements

20,000 Units Manufactured


$35 + ($400,000 ÷ 20,000)

Sales $1,500,000 $1,500,000Cost of goods sold:

Cost of goods manufactured(20,000 units x $55) $1,100,000





Cost of goods manufactured(20,000 units x $55) $1,100,000(25,000 units x $51) $1,275,000

$35 + ($400,000 ÷ 25,000)





Cost of goods manufactured(20,000 units x $55) $1,100,000(25,000 units x $51) $1,275,000

Less ending inventory:(5,000 units x $51) 255,000

Cost of goods sold $1,100,000 $1,020,000Gross profit $ 400,000 $ 480,000Selling and administrative expenses

($100,000 + $100,000) 200,000 200,000Income from operations $ 200,000$ 200,000 $ 280,000$ 280,000

Now, assume that Frand Manufacturing uses variable costing.

Now, assume that Frand Manufacturing uses variable costing.

Frand Manufacturing CompanyVariable Costing Income Statements



Sales $1,500,000 $1,500,000Variable cost of goods sold:

Variable cost of goods manufactured:(20,000 units x $35) $ 700,000(25,000 units x $35) $ 875,000

Direct materials, direct labor, and variable manufacturing overhead only.




Sales $1,500,000 $1,500,000Variable cost of goods sold:

Variable cost of goods manufactured:(20,000 units x $35) $ 700,000(25,000 units x $35) $ 875,000

Less ending inventory:(0 units x $35) 0(5,000 units x $35) 175,000

Variable cost of goods sold $ 700,000 $ 700,000Manufacturing margin $ 800,000 $ 800,000

ContinuedContinuedContinuedContinued




Manufacturing margin $ 800,000 $ 800,000Variable selling and administrative

expenses 100,000 100,000Contribution margin $ 700,000 $ 700,000Fixed costs:

Fixed manufacturing costs $ 400,000 $ 400,000Fixed selling and administrative

expenses 100,000 100,000Total fixed costs $ 500,000 $ 500,000

Income from operations $ 200,000 $ 200,000

What would be the income from operations if the firm manufactured 30,000 units?

What would be the income from operations if the firm manufactured 30,000 units?



Sales $1,500,000Variable cost of goods sold:

Variable cost of goods manufactured:(30,000 units x $35) $1,050,000

Less ending inventory:(10,000 units x $35) 350,000

Variable cost of goods sold $ 700,000Manufacturing margin $ 800,000




Manufacturing margin $ 800,000Variable selling and administrative

expenses 100,000Contribution margin $ 700,000Fixed costs:

Fixed manufacturing costs $ 400,000Fixed selling and administrative

expenses 100,000Total fixed costs $ 500,000

Income from operations $ 200,000

Management’s Use of Costing MethodsManagement’s Use of Costing MethodsManagement’s Use of Costing MethodsManagement’s Use of Costing Methods

1. Controlling costs

2. Pricing products

3. Planning production

4. Analyzing market segments

5. Analyzing contribution margins

Variable costing reports and absorption costing reports are useful in the following situations:

Accounting Reports and Accounting Reports and Management DecisionsManagement DecisionsAccounting Reports and Accounting Reports and Management DecisionsManagement Decisions

ACCOUNTING REPORTS

Absorption Costing and Variable Costing

MANAGEMENT

MANAGEMENT

DECISIONS

Controlling Controlling CostsCosts

PricingPricingPlanning Planning

ProductionProduction

Analyzing Analyzing Market Market

SegmentsSegments

Analyzing Analyzing Contribution Contribution

MarginsMargins

ACTUAL PLANNED

Pricing ProductsPricing ProductsPricing ProductsPricing Products

In the short run, we are committed to our existing manufacturing facilities.

In the short run, we are committed to our existing manufacturing facilities.


That is correct. The pricing decision should be based upon making the best

use of our existing capacity.

That is correct. The pricing decision should be based upon making the best

use of our existing capacity.


Even in the long-run where plant capacity can be changed, the selling prices of our products must cover all

costs and provide a reasonable income.

Even in the long-run where plant capacity can be changed, the selling prices of our products must cover all

costs and provide a reasonable income.

Analyzing Market SegmentAnalyzing Market SegmentAnalyzing Market SegmentAnalyzing Market Segment

A market segment is a portion of business that

can be assigned to a manager for profit

responsibility.

A market segment is a portion of business that

can be assigned to a manager for profit

responsibility.

Contribution Margin Reporting Contribution Margin Reporting for Market Segmentsfor Market Segments

Contribution Margin Reporting Contribution Margin Reporting for Market Segmentsfor Market Segments

Camelot Fragrance Company manufactures and sells the Gwenevere perfume for women and the Lancelot cologne line for men. The

inventories are negligible.

Camelot Fragrance Company manufactures and sells the Gwenevere perfume for women and the Lancelot cologne line for men. The

inventories are negligible.

Northern Southern Territory Territory Total

Sales:Gwenevere $60,000 $30,000 $ 90,000Lancelot 20,000 50,000 70,000

Total territory sales $80,000 $80,000 $160,000

Variable production costs:Gwenevere (12% of sales) $ 7,200 $ 3,600 $ 10,800Lancelot (12% of sales) 2,400 6,000 8,400

Total variable production cost by territory $ 9,600 $ 9,600 $ 19,200


Promotion costs:Gwenevere (30% of sales) $18,000 $ 9,000 $ 27,000Lancelot(20% of sales) 4,000 10,000 14,000

Total variable productioncost by territory $22,000 $19,000 $ 41,000

Sales commissions:Gwenevere (20% of sales) $12,000 $ 6,000 $ 18,000Lancelot (12% of sales) 2,000 5,000 7,000

Total sales commissionby territory $14,000 $11,000 $ 25,000

Northern Southern Territory Territory Total

Sales $80,000 $80,000Variable cost of goods sold 9,600 9,600Manufacturing margin $70,400 $70,400Variable selling expenses:

Promotion costs $22,000 $19,000Sales commissions 14,000 11,000 Total $36,000 $30,000

Contribution margin $34,400 $40,400

Contribution margin ratio 43% 50.5%

Camelot Fragrance CompanyContribution Margin by Sales TerritoryFor the Month Ended March 31, 2006

Northern SouthernTerritory Territory

Sales $90,000 $70,000Variable cost of goods sold 10,800 8,400Manufacturing margin $79,200 $61,600Variable selling expenses:

Promotion costs $ 27,000 $14,000Sales commissions 18,000 7,000 Total $45,000 $21,000

Contribution margin $34,200 $40,600

Contribution margin ratio 38% 58%

Gwenevere Lancelot

Camelot Fragrance CompanyContribution Margin by Product Line

For the Month Ended March 31, 2006

Sales $20,000 $20,000 $40,000 $80,000Variable cost of goods sold 2,400 2,400 4,800 9,600Manufacturing margin $17,600 $17,600 $35,200 $70,400Variable selling expenses:

Promotion costs $ 5,000 $ 5,000 $12,000 $22,000Sales commissions 3,000 3,000 8,000 14,000

$ 8,000 $ 8,000 $20,000 $36,000Contribution margin $ 9,600 $ 9,600 $15,200 $34,400

Contribution margin ratio 48% 48% 38% 43%

Sales mix (% Lancelot sales) 50% 50% 0% 25%

Camelot Fragrance CompanyContribution Margin by Salesperson—Northern Territory

For the Month Ended March 31, 2003

Inez Tom BethRodriquez Ginger Williams Total

Contribution Margin AnalysisContribution Margin AnalysisContribution Margin AnalysisContribution Margin Analysis

Planned Contribution

Margin

Actual Contribution

Margin–

Sales Variable Cost of Goods Sold

Variable Selling and

Administrative Expenses


Contribution Margin AnalysisContribution Margin AnalysisContribution Margin AnalysisContribution Margin Analysis

Sales Variable Cost of Goods Sold

Variable Selling and

Administrative Expenses

Quantity Factor

+/–Price Factor

Quantity Factor

+/–Unit Cost

Factor

Quantity Factor

+/–Unit Cost

Factor

Changes in Contribution Margin as a Changes in Contribution Margin as a Result of Quantity and Price FactorsResult of Quantity and Price Factors

Changes in Contribution Margin as a Changes in Contribution Margin as a Result of Quantity and Price FactorsResult of Quantity and Price Factors

The difference between the actual quantity sold and the planned quantity sold, multiplied by the planned unit sales price or unit cost.

Quantity factorQuantity factor

Unit price or unit cost factorUnit price or unit cost factor

The difference between the actual unit price or unit cost and the planned unit price or unit cost, multiplied by the actual quantity sold.

Noble Inc. for Year Ended Noble Inc. for Year Ended December 31, 2006December 31, 2006


Actual PlannedIncrease or (Decrease)

Sales $937,500 $800,000$137,500

Less: Variable cost of

goods sold $425,000 $350,000$ 75,000

Variable selling andadministrative exp. 162,500 125,000 37,500

Total $587,500 $475,000$112,500

Contribution margin $350,000 $325,000$ 25,000




Actual Planned

Number of units sold 125,000 100,000

Per unit: Sales price $7.50 $8.00Variable cost of goods sold $3.40 $3.50

Variable selling andadministrative exp. $1.30 $1.25

Contribution Margin ReportContribution Margin ReportContribution Margin ReportContribution Margin Report

Blue Skies Airlines Inc. operates a small commercial airline.

Blue Skies Airlines Inc. operates a small commercial airline.

Blue Skies Airlines Inc.Contribution Margin and Income from Operations Report

for the Month Ended April 30, 2006

Revenue$19,238,000

Variable costs:Fuel expense $4,080,000Wages expense 6,120,000Food and beverage service exp. 444,000Selling expenses 3,256,000 13,900,000

Contribution margin$ 5,338,000

Fixed costs:Depreciation expense $3,600,000Rental expense 800,000 4,400,000

Income from operations$ 938,000$ 938,000

Blue Skies Airlines Inc.Contribution Margin by Route Report—Chicago/Atlanta


Revenue$6,400,000

Variable costs:Fuel expense $1,120,000Wages expense 1,680,000Food and beverage service exp. 240,000Selling expenses 1,760,000 4,800,000

Contribution margin$1,600,000

Contribution Margin Ratio = 0.25Contribution Margin Ratio = 0.25Contribution Margin Ratio = 0.25Contribution Margin Ratio = 0.25

Blue Skies Airlines Inc.Contribution Margin by Route Report—Atlanta/Los Angeles


Revenue $7,525,000Variable costs:

Fuel expense $1,760,000Wages expense 2,640,000Food and beverage service exp. 105,000Selling expenses 770,000 5,275,000

Contribution margin $2,250,000


Blue Skies Airlines Inc.Contribution Margin by Route Report—Los Angeles/Chicago


Revenue $5,313,000Variable costs:

Fuel expense $1,200,000Wages expense 1,800,000Food and beverage service exp. 99,000Selling expenses 726,000 3,825,000

Contribution margin $1,488,000


Blue Skies Airlines Inc.Contribution Margin—Chicago/Atlanta

Revenue $7,600,000 $6,400,000Less variable expenses:

Fuel expense $1,232,000 $1,120,000Wages expense 1,680,000 1,680,000Food and beverage service exp. 300,000 240,000Selling expenses and commiss. 2,200,000 1,760,000

Total $5,412,000 $4,800,000Contribution margin $2,188,000 $1,600,000

Contribution Margin RatioContribution Margin Ratio 0.290.290.250.25

Contribution Margin RatioContribution Margin Ratio 0.290.290.250.25

Actual—May Planned—May


Blue Skies Airlines Inc.Contribution Margin—Chicago/Atlanta

Number of miles flown 56,000 56,000Number of passengers flown 20,000 16,000Per unit:

Ticket price $380 $400Fuel expense 22 20Wages expense 30 30Food and beverage service exp. 15 15Selling expenses 110 110

Actual—May Planned—May

Contribution Margin Analysis Contribution Margin Analysis ReportReport—Service Company—Service Company


Blue Skies Airlines Inc.Contribution Margin Analysis

For the Month Ended May 31, 2006

Increase in revenue attributed to:Quantity factor:

Increase in the number of tickets soldin May (4,000 x $400) $1,600,000

Price factor:Decrease in the ticket price in May

($20 x 20,000) (400,000)Net increase in revenue $1,200,000






Increase in fuel costs attributed to:Unit cost factor:

Increase in unit cost in May times number of miles flown ($2 x 56,000) $112,000






Increase in food and beverage servicecosts attributed to:

Quantity factor:Increase in number of tickets sold in May times planned unit cost in May (4,000 x $15.00) $60,000






Increase in selling costs and commissionsattributed to:

Quantity factor:Increase in number of tickets sold in May times planned unit cost in May (4,000 x $110) $440,000






Summary:Net increase in revenue $1,200,000Net increase in fuel cost (112,000)Net increase in food and beverage service costs (60,000)Net increase in selling costs (440,000)

Increase in contribution margin $ 588,000

The EndThe End

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