3. Presentation Outline
Absorption Costing v. Variable Costing.
A Comparison of Income Data for
Absorption Costing and Variable
Costing.
An Illustration.
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4. Absorption Costing v. Variable
Costing
A. Cost Classifications
B. Fixed Manufacturing Overhead
C. Format of Income Statement
D. Report Usage
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5. (A). Cost Classifications
Absorption Costing Variable Costing
Product costs include:
> Direct materials
> Direct labor
> Variable mfg. overhead
> Fixed mfg. overhead
Product costs include:
> Direct materials
> Direct labor
> Variable mfg. overhead
Period costs include:
> Selling & admin. expenses
Period costs include:
> Selling & admin. expenses
> Fixed mfg. overhead
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6. Overview of Variable and
Absorption Costing
Direct Materials
Direct Labor
Variable Manufacturing Overhead
Fixed Manufacturing Overhead
Variable Selling and Administrative Expenses
Fixed Selling and Administrative Expenses
Variable
Costing
Absorption
Costing
ProductProduct
CostsCosts
PeriodPeriod
CostsCosts
ProductProduct
CostsCosts
PeriodPeriod
CostsCosts
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7. (B). Fixed Manufacturing Overhead
Absorption Costing Variable Costing
Fixed manufacturing overhead
is treated as a product cost.
Fixed manufacturing overhead is
treated as a period cost and
deducted in full each year from
revenues.
Balance Sheet
Fixed mfg. overhead
Fixed mfg.
overhead is
never an
asset.
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8. (C). Format of Income Statement
Full (Absorption) Costing Variable Costing
Sales
- Cost of goods sold
= Gross margin
- Selling & admin. expenses
= Net income
Sales
- Variable expenses
= Contribution margin
- Fixed expenses
= Net income
Students See Illustration of chapter 6 for detail 8
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9. (D). Report Usage
Absorption costing
is required for
external reporting.
Variable costing is
permitted for internal
use only.
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10. A Comparison of Income Data
for Absorption Costing and
Variable Costing
A. Production = Sales (no change in inventories)
B. Production > Sales (inventories increase)
C. Production < Sales (inventories decrease)
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11. (A) Production = Sales
(No change in inventories)
Absorption Costing
Net Income
Variable Costing Net
Income
If there is no change in inventories, then there is
generally no change in the fixed manufacturing
overhead costs in inventories under absorption costing.
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12. (B) Production > Sales
(Inventories increase)
Absorption Costing
Net Income
Variable Costing Net
Income
If inventories increase, then some of the current fixed
manufacturing overhead costs will be deferred in
inventories under absorption costing.
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13. (C) Production < Sales
(Inventories decrease)
Absorption Costing
Net Income
Variable Costing Net
Income
If inventories decrease, then some of the prior fixed
manufacturing overhead costs that had been deferred
in inventories under absorption costing, will be released
as a current charge against income.
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14. An Illustration
Selling price per unit $2,000
Variable costs per unit:
Direct materials $ 600
Direct labor $ 225
Variable manufacturing overhead $ 75
Variable selling and administrative expenses $ 40
Fixed costs per year:
Fixed manufacturing overhead $1,200,000
Fixed selling expenses $ 100,000
Fixed administrative expenses $ 500,000
Annual production in units 5,00014
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18. Variable Costing Income Statement
Sales (5,000 units x $2,000) 10,000,000
Less variable expenses
Cost of goods sold:
Beginning finished goods inventory 0
Cost of goods mfg (5,000 units x $900) 4,500,000
Goods available for sale 4,500,000
Ending fin. goods inventory 0
Cost of goods sold 4,500,000
Selling expense (5,000 units x $40) 200,000
Contribution margin 5,300,000
Less fixed expenses:
Manufacturing overhead 1,200,000
Selling expense 100,000
Administrative expense 500,000
Net income 3,500,000
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19. Abosorption Costing Income Statement
Sales (5,000 units x $2,000) 10,000,000
Less cost of goods sold:
Beginning finished goods inventory 0
Cost of goods mfg (5,000 units x $1,140) 5,700,000
Goods available for sale 5,700,000
Ending fin. goods inventory 0
Cost of goods sold 5,700,000
Gross margin 4,300,000
Operating expenses:
Selling expenses ($100,000 + (5,000 units x $40) 300,000
Administrative expenses 500,000
Net operating income 3,500,000
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21. Variable Costing Income Statement
Sales (4,800 units x $2,000) 9,600,000
Less variable expenses
Cost of goods sold:
Beginning finished goods inventory 0
Cost of goods mfg (5,000 units x $900) 4,500,000
Goods available for sale 4,500,000
Ending fin. goods inventory (200 units x $900) 180,000
Cost of goods sold 4,320,000
Selling expense (4,800 units x $40) 192,000
Contribution margin 5,088,000
Less fixed expenses:
Manufacturing overhead 1,200,000
Selling expense 100,000
Administrative expense 500,000
Net income 3,288,000
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22. Abosorption Costing Income Statement
Sales (4,800 units x $2,000) 9,600,000
Less cost of goods sold:
Beginning finished goods inventory 0
Cost of goods mfg (5,000 units x $1,140) 5,700,000
Goods available for sale 5,700,000
End. fin. goods inv. (200 units x $1,140) 228,000
Cost of goods sold 5,472,000
Gross margin 4,128,000
Operating expenses:
Selling expenses ($100,000 + (4,800 units x $40) 292,000
Administrative expenses 500,000
Net operating income 3,336,000
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23. Reconciliation of the operating income between variable costing and absorption
costing
Variable costing net income 3,288,000
- Fixed manufacturing overhead released from
beginning inventory
0 units x $240 0
+ Fixed manufacturing overhead deferred in
ending inventory
200 units x $240 48,000
Absorption costing net income 3,336,000
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25. Variable Costing Income Statement
Sales (5,200 units x $2,000) 10,400,000
Less variable expenses
Cost of goods sold:
Beginning fin. goods inv. (200 units x $900) 180,000
Cost of goods mfg (5,000 units x $900) 4,500,000
Goods available for sale 4,680,000
Ending fin. goods inventory 0
Cost of goods sold 4,680,000
Selling expense (5,200 units x $40) 208,000
Contribution margin 5,512,000
Less fixed expenses:
Manufacturing overhead 1,200,000
Selling expense 100,000
Administrative expense 500,000
Net income 3,712,000
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26. Abosorption Costing Income Statement
Sales (5,200 units x $2,000) 10,400,000
Less cost of goods sold:
Beg. Fin. goods inv. (200 units x $1,140) 228,000
Cost of goods mfg (5,000 units x $1,140) 5,700,000
Goods available for sale 5,928,000
End. fin. goods inv. 0
Cost of goods sold 5,928,000
Gross margin 4,472,000
Operating expenses:
Selling expenses ($100,000 + (5,200 units x $40) 308,000
Administrative expenses 500,000
Net operating income 3,664,000
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27. Reconciliation of the operating income between variable costing and absorption
costing
Variable costing net income 3,712,000
- Fixed manufacturing overhead released from
beginning inventory
200 units x $240 48,000
+ Fixed manufacturing overhead deferred in
ending inventory
0 units x $240 0
Absorption costing net income 3,664,000
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28. A Comparison of Incomes
Absorption
Net Income
Variable Net
Income
Year 1
(Production =
Sales)
3,500,000 3,500,000
Year 2
(Production >
Sales)
3,336,000 3,288,000
Year 3
(Production <
Sales)
3,664,000 3,712,000
3 Year Totals 10,500,000 10,500,000When total production over the 3 year period = total sales over that
period, total net income under the approaches is equal. 28
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29. Summary of Key Insights
Relation between Relation between
production Effect on variable and
and sales inventory absorption income
Units produced Absorption
= No change =
Units sold in inventory Variable
Units produced Absorption
> Inventory >
Units sold increases Variable
Units produced Absorption
< Inventory <
Units sold decreases Variable
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Hinweis der Redaktion
Chapter 6: Variable Costing and Segment Reporting: Tools for Management
Two general approaches are used for valuing inventories and cost of goods sold. One approach, called absorption costing, is generally used for external reporting purposes. The other approach, called variable costing, is preferred by some managers for internal decision making and must be used when an income statement is prepared in the contribution format. This chapter shows how these two methods differ from each other. It also explains how to create segmented contribution format income statements.
Variable costing (also called direct costing or marginal costing) treats only those costs of production that vary with output as product costs. This approach dovetails with the contribution approach income statement and supports CVP analysis because of its emphasis on separating variable and fixed costs. The cost of a unit of product consists of direct materials, direct labor, and variable overhead. Fixed manufacturing overhead, and both variable and fixed selling and administrative expenses are treated as period costs and deducted from revenue as incurred.
Absorption costing (also called the full cost method) treats all costs of production as product costs, regardless of whether they are variable or fixed. Since no distinction is made between variable and fixed costs, absorption costing is not well suited for CVP computations. Under absorption costing, the cost of a unit of product consists of direct materials, direct labor, and both variable and fixed overhead. Variable and fixed selling and administrative expenses are treated as period costs and are deducted from revenue as incurred.
On your screen is a summary of what we have observed from the Harvey Company’s two years:
When units produced equal units sold, the two methods report the same net operating income.
When units produced are greater units sold, as in year 1 for Harvey, absorption income is greater than variable costing income.
When units produced are less than units sold, as in year 2 for Harvey, absorption costing income is less than variable costing income.