1. Cost Management Session 7

2. Overview Theory Exercise: 10.33, 10.37, 10.56, 10.60 2

3. Theory This costs method includes allocating direct material, direct labor, and both variable and fixed manufacturing overhead to the costs of production The absorption costing method treats all cost as a cost of production whether they are variable or fixed. 3 Absorption Costing

4. Variable (direct) costing 4 Direct costing is a method used to determine the cost of a product by allocating its direct cost to it. This method calculates the costs of production by including direct materials, direct labor and sometimes a variable portion of manufacturing overhead.

5. Throughput costing 5 Is a costing method that assigns only the out-of- pocket spending as the cost of products or services. Out-of-pocket costs are costs requiring cash payments in the current accounting period.

6. Exercise 10.33 (a)Compute the amount that overhead was over-applied or under-applied. 6

7. 7 Predetermined overhead rate =estimated overhead/estimated allocation base =$900,000/100,000 hours =$9 per hour Applied overhead =predetermined overhead rate x actual allocation base =$9 per hour x 110,000 hours =€990,000 Overhead variance =applied overhead - actual overhead =$990,000 - $980,000 =$10,000 overapplied

8. 8 (b)Should this variance be closed to Cost of sales?

9. 9 The overapplied overhead of 10.000 (+) can be divided into a negative overhead spending variance of 80.000 (900.000 minus 980.000) and a positive volume variance of 90.000 (110.000 - 100.000) * 9. These two variances should stay in the department were they were caused, so no transfer to the cost of sales

10. Exercise 10.37 (a)Compute the standard accrual product cost per container of ketchup under (1) absorption costing and (2) variable costing 10

11. 11 Since there were no variances in 20x0, actual production and budgeted production must have been the same. Predetermined fixed overhead rate = = = kr 14 per unit Direct material kr 35 Direct labor 14 Variable overhead 21 Standard cost per unit under variable costing kr 70 Fixed overhead per unit under absorption costing 14 Standard cost per unit under absorption costing kr 84

12. b) Prepare a statement of income for 20x0 using (1)absorption costing and variable costing 12

13. 13 Revenue Kr 14,000,000 Less: Cost of sales Cost of sales Kr 10,500,000 Gross margin Kr 3,500,000 Less: Selling and Adm. expenses Fixed Kr 350,000 Variable Kr 875,000 Net Income Kr 2,275,000 (1)Absorption costing

14. (2) Variable costing Revenue Kr 14,000,000 Less: Variable expenses Variable manufacturing costs Kr 8,750,000 Variable selling and administrative costs Kr 875,000 Contribution margin Kr 4,375,000 Less: fixed expenses Manufacturing overhead Kr 2,100,000 Selling and adm.expenses Kr 350,000 Net Income Kr 1,925,000 14

15. c) Reconcile the income reported under the two methods 15

16. Cost of sales under absorption costing kr 10,500,000 Less:Variable manufacturing costs under variable costing kr 8,750,000 Differencekr 1,750,000 Less:Fixed manufacturing overhead as period expense under variable costing kr 2,100,000 Total kr (350,000) Net income under variable costing kr 1,925,000 Less:Net income under absorption costing kr 2,275,000 Difference in net income kr (350,000) 16

17. 10.56 a) Prepare a variable-costing statement of income for the year. 17

18. 18 Revenue €465,000 Cost of sales: Beginning inventory (€22,000 x 45%) € 9,900 Cost of goods manufactured (€315,000 x 70%) 220,500 Ending inventory (€86,000 x 70%)(60,200) 170,200 Variable selling costs (€83,000 x 80%) 66,400 Variable admin. costs (€49,800 x 40%) 19,920 Contribution margin 208,480 Fixed manufacturing costs (€315,000 x 30%) 94,500 Fixed selling costs (€83,000 x 20%) 16,600 Fixed administrative costs (€49,800 x 60%) 29,880 Operating profit before tax (variable costing) € 67,500

19. b) Write a short report to management that explains why the company might be experiencing a cash-flow shortage despite the adequate income shown in its absorption- costing statement of income. 19

20. Points to include in report to management: (1)Reconciliation of full-absorption operating profit to variable costing operating profit. Operating profit before tax: absorption costing€ 81,200 Add: fixed costs in beginning inventory (€22,000 x 55%) € 12,100 Deduct: fixed costs in ending inventory (€86,000 x 30%) € 25,800 Operating profit before tax: variable costing€ 67,500 (2)Operating profit using full-absorption costing is high (relative to variable costing) because fixed manufacturing costs are assigned both to goods sold and goods in inventory at the end of the period. Although some of the fixed manufacturing costs are deferred on the statement of income, they are likely paid for with cash in the current period. 20

21. 10.60 a) Compute the company’s total costs for the year assuming that (1) variable manufacturing costs are driven by the number of units produced and (2) variable selling and adm.costs are driven by the number of units sold. 21

22. Total cost: Direct material (10,000 units x $12)$ 120,000 Direct labour$ 45,000 Variable manufacturing overhead$ 65,000 Fixed manufacturing overhead$ 220,000 Variable selling and administrative costs (9,600 units x $8)$ 76,800 Fixed selling and administrative costs $ 118,000 Total$644,800 22

23. b) How much of this cost would be held in year- end inventory under (1) absorption costing, (2) variable costing, and (3) throughput costing. 23

24. (1) Absorption Costing (2) Variable Costing (3) Throughput Costing Direct material$120,000 Direct labour 45,000 - Variable manufacturing overhead 65,000 - Fixed Manufacturing overhead 220,000 -- Total product cost$450,000$230,000$120,000 Cost per unit (total ÷ 10,000 units) $45$23$12 Year-end inventory (400 units x cost per unit) $18,000$9,200$4,800 24 The cost of the year-end inventory of 400 units (10,000 units produced – 9,600 units sold) is computed as follows:

25. c)How much of the company’s total cost for the year would be included as an expense on the period’s statement of income under (1) absorption costing, (2) variable costing and (3) throughput costing? 25

26. (1) Absorption Costing Direct material(3) Throughput Costing Cost of sales$432,000$220,800$115,200 Direct labour $45,000 Variabele manufacturing overhead $65,000 Fixed manufacturing overhead $220,000 Variable selling and adm. costs $76,800 Fixed seeling and adm.costs $118,000 Total$626,800$635,600$640,000 26

27. d) Prepare the company’s throughput-costing statement of income. 27

28. 28 Sales revenue (9,600 units x $80)$768,000 Less: Cost of sales$115,200 Throughput$652,800 Less: Operating costs: Direct labour$45,000 Variable manufacturing overhead $65,000 Fixed manufacturing overhead $220,000 Variable selling and administrative costs $76,800 Fixed selling and administrative costs $118,000 Total operating costs$524,800 Net income$128,000* Net income = sales revenue - all costs expenses = $768,000 - $640,000 ([from req. (c)] = $128,000

29. 29 READY FOR TEST?

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41. See you next week! 41