ACCT312 Week 2 Cost management systems 1
Variable costing Absorption costing 2
Cos measurement systems Process Job Variable Absorption Variable Absorption Actual Standard Normal Standard Actual Normal Standard Normal Standard Normal Actual Actual 3
TOTAL COSTS Manufacturing Non Manufacturing Variable Direct Costs D. Materials Indirect Costs Electricity Indirect materials Variable Sales and Distribution Commissions Fuel Variable Admin D. Labour Subcontracts Telecommunications Stationery Fixed Indirect Costs Fixed Sales and Distribution Fixed Admin Fixed Rent Depreciation Supervisory salaries Security Rent Depreciation Salaries Advertising Rent Depreciation Salaries Absorption Costing (Period Costs) 4
Absorption and variable costing 1. Absorption costing (also known as full costing) traces/allocates variable and fixed manufacturing costs to products and treats non-manufacturing overheads as a period cost. 2. Variable costing (also known as marginal costing) traces/allocates variable manufacturing costs to products and treats fixed manufacturing overheads and non-manufacturing overheads as a period cost. 3. Therefore variable and absorption costing differ only in the treatment of fixed manufacturing overheads. 5
Absorption and variable costing 6
Costing Comparison Variable costing is a method of inventory costing in which only variable manufacturing costs are included as inventoriable costs Absorption costing is a method of inventory costing in which all variable manufacturing costs and all fixed manufacturing costs are included as inventoriable costs Throughput Costing is a modified variable costing only Direct Materials are capitalized; all other costs are expensed 7
Differences in Income Operating Income will differ between Absorption and Variable Costing The amount of the difference represents the amount of Fixed Product Costs capitalized as Inventory under Absorption costing, and expensed as a period costs under Variable Costing 8
Comparative Income Effects Variable Costing Absorption Costing Are fixed product costs inventoried? No Yes Is there a production-volumevariance? No Yes 9
Profit comparisons Profits are the same for both methods when production equals sales (and there are no changes in stock levels) Where production exceeds sales (increasing stock levels) the absorption costing system produces higher profits Where sales exceed production (declining stock levels) the variable costing system produces higher profits 10
Comparative Income Effects Variable Costing Absorption Costing How do changes in unit inventory affect operating income if? Production = Sales Equal Equal Production > Sales Lower Higher Production < Sales Higher Lower 11
Comparative Income Effects What are the effects on costvolume-profit (for a given level of fixed costs and a given contribution margin per unit? Variable Costing Driven by: unit level of sales Absorption Costing Driven by: 1. Unit level of sales 2. Unit level of production 3. Chosen denominator level 12
Variable Standard Cos measurement systems Both Process and job costing Absorption Actual Normal Actual Normal Standard 13
Exercise 9-16 Variable and absorption costing, explaining operating-income differences Nascar Motors assembles and sells motor vehicles and uses standard costing. Actual data relating to April and May 2008 are: 14
The following information is available: The selling price per vehicle is $24,000. The budgeted level of production used to calculate the budgeted fixed manufacturing cost is for 500 units per period (month). So, what is the fixed manufacturing rate per unit? $2,000,000/500= $4,000 There are no price, efficiency, or spending variances. Any production-volume variance is written off to cost of goods sold in the month in which it occurs. 15
1. Prepare April and May 2008 income statements for Nascar Motors under: (a) variable costing (b) absorption costing 16
17 (a) variable costing
18 (b) absorption costing
2. Prepare a numerical reconciliation and explanation of the difference between operating income for each month under variable costing and absorption costing. The difference between absorption and variable costing is due solely to moving fixed manufacturing costs into inventories as inventories increase (as in April) and out of inventories as they decrease (as in May). 19
Extreme Variable Costing: Throughput Costing Throughput costing (super-variable costing) is a method of inventory costing in which only direct material costs are included as inventory costs. All other product costs are treated as operating expenses 20
21 Throughput Costing Illustrated
Exercise 9-18 Variable and absorption costing, explaining operatingincome differences BigScreen Corporation manufactures and sells 50-inch television sets and uses standard costing. The selling price per unit is $2,500. The budgeted level of production used to calculate the budgeted fixed manufacturing cost per unit is 1,000 units. There are no price, efficiency, or spending variances. Any production-volume variance is written off to cost of goods sold in the month in which it occurs. 22
23 Actual data relating to January, February, and March of 2009 are:
Prepare income statements for BigScreen in January, February, and March of 2009 under (a) variable costing and (b) considering the changes in beginning and ending inventories calculate expected income under absorption costing (no income statement is required) 24
(a) variable costing 25
(b) considering the changes in beginning and endi ng inventories, calculate expected income under a bsorption costing (no income statement is require Income under absorption costing =Income under variable costing +(net change (+-) in inventories fixed manufacturing overhead rate January: $160,000+ (300-0) $400) = $280,000 February: $260,000 +(300-300) $400 = $260,000 March: $960,000 +(50-300) $400 =$860,000 26
27 Costing Systems Compared
Comparison of Alternative Inventory Costing Systems Variable Direct Manufacturing Cost for both methods Actual Costing Normal Costing Standard Costing Actual Prices X Actual Quantity of inputs used Actual Prices X Actual Quantity of inputs used Standard prices X Standard Quantity of inputs allowed for actual output achieved 28
Comparison of Alternative Inventory Costing Systems Variable Indirect Manufacturing Cost for both methods Actual Costing Normal Costing Standard Costing Actual variable indirect rates X Actual quantity of cost-allocation bases used Budgeted variable indirect rates X Actual quantity of cost-allocation bases used Standard variable indirect rates X Standard quantity of cost-allocation bases allowed for actual output achieved 29
Comparison of Alternative Inventory Costing Systems Fixed Direct Manufacturing Cost only for absorption costing Not very common (usually all fixed costs are considered as indirect Actual Costing Normal Costing Standard Costing Actual prices X Actual quantity of inputs used Actual prices X Actual quantity of inputs used Standard prices X Standard quantity of inputs allowed for actual output achieved 30
Comparison of Alternative Inventory Costing Systems Fixed Indirect Manufacturing Cost only for absorption costing Actual Costing Normal Costing Standard Costing Actual fixed indirect rates X Actual quantity of cost-allocation bases used Budgeted fixed indirect rates X Actual quantity of cost-allocation bases used Standard fixed indirect rates X Standard quantity of cost-allocation bases allowed for actual output achieved 31
Comparison of Alternative Inventory Costing Systems Except actual costing, there could be over or under applied when using overhead rates 32
Performance Issues and Absorption Costing Managers may seek to manipulate income by producing too many units Production beyond demand will increase the amount of inventory on hand This will result in more fixed costs being capitalized as inventory That will leave a smaller amount of fixed costs to be expensed during the period Profit increases, and potentially so does a manger s bonus 33
Inventories and Costing Methods One way to prevent the unnecessary buildup of inventory for bonus purposes is to base manager s bonuses on profit calculated using Variable Costing Drawback: complicated system of producing two inventory figures one for external reporting and the other for bonus calculations 34
Other Manipulation Schemes Beyond Simple Overproduction Deciding to manufacture products that absorb the highest amount of fixed costs, regardless of demand ( cherry-picking ) Accepting an order to increase production, even though another plant in the same firm is better suited to handle that order Deferring maintenance 35
Management Countermeasures for Fixed Cost Manipulation Schemes Careful budgeting and inventory planning Incorporate an internal carrying charge for inventory Change (lengthen) the period used to evaluate performance (e.g. 3 years or more) Include nonfinancial as well as financial variables in the measures to evaluate performance 36
Exercise 9-21 Absorption and variable costing Osawa, Inc., planned and actually manufactured 200,000 units of its single product in 2009, its first year of operation. Variable manufacturing cost was $20 per unit produced. Variable operating (non-manufacturing) cost was $10 per unit sold. Planned and actual fixed manufacturing costs were $600,000. Planned and actual fixed operating (non-manufacturing) costs totaled $400,000. Osawa sold 120,000 units of product at $40 per unit. 37
1. Osawa s 2009 operating income using absorption costing is: (a) $440,000 (b) $200,000 (c) $600,000 (d) $840,000 (e) none of these 38
39 Answer: (a)
2. Osawa s 2009 operating income using variable costing is: (a) $800,000 (b) $440,000 (c) $200,000 (d) $600,000 (e) none of these 40
Answer: (c) 41
Which method? Some arguments in support of variable costing Variable costing provides more useful information for decisionmaking Variable costing removes from profit the effect of stock changes Variable costing avoids fixed overheads being capitalized in unsaleable stocks Some arguments in support of absorption costing Absorption Costing does not understate the importance of fixed costs Revenue Production Concept favours absorption costing Consistency with external reporting 42