Chapter 5 Variable Costing for Management Analysis Student Version These slides should be viewed using the presentation mode (left click your mouse on the icon). Prepared by: C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University 1 © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Learning Objective 1 Describe and illustrate reporting income from operations under absorption and variable costing.

Absorption and Variable Costing LO 1 Absorption and Variable Costing Absorption costing is required under generally accepted accounting principles for financial statements distributed to external users. For internal use in decision making, managers often use variable costing, sometimes called direct costing. Under variable costing, the cost of goods manufactured includes only variable manufacturing costs.

LO 1 Variable Costing Manufacturing margin is sales less variable cost of goods sold. Variable cost of goods sold consists of direct materials, direct labor, and variable factory overhead for the units sold. Contribution margin is manufacturing margin less variable selling and administrative expenses.

Comparing Variable and Absorption Costing LO 1 Comparing Variable and Absorption Costing Assume that 15,000 units are manufactured and sold at a price $50.

Units Manufactured Equal Units Sold LO 1 Units Manufactured Equal Units Sold

Units Manufactured Less Than Units Sold LO 1 Units Manufactured Less Than Units Sold Assume that 5,000 units of inventory were on hand at the beginning of a period, 10,000 units were manufactured during the period, and 15,000 units were sold at $50 per unit.

Units Manufactured Less Than Units Sold LO 1 Units Manufactured Less Than Units Sold

Units Manufactured Less Than Units Sold LO 1 Units Manufactured Less Than Units Sold

Units Manufactured Less Than Units Sold LO 1 Units Manufactured Less Than Units Sold

Learning Objective 2 Describe and illustrate the effects of absorption and variable costing on analyzing income from operations.

Frand Manufacturing Company LO 2 Frand Manufacturing Company FRAND Frand Manufacturing Company has no beginning inventory, and sales are estimated to be 20,000 units at $75 per unit, regardless of production levels. The management of Frand Manufacturing Company is evaluating whether to manufacture 20,000 units (Proposal 1) or 25,000 units (Proposal 2).

LO 2 Proposal 1 FRAND

LO 2 Proposal 2 FRAND

Income Analysis Under Absorption and Variable Costing LO 2 Income Analysis Under Absorption and Variable Costing FRAND

Describe management’s use of absorption and variable costing. Learning Objective 3 Describe management’s use of absorption and variable costing.

LO 3 Controlling Costs For a specific level of management, controllable costs are costs that can be influenced by management at that level. Noncontrollable costs are costs that another level of management controls.

LO 3 Pricing Products Many factors enter into determining the selling price of a product. The cost of making the product is significant in all pricing decisions. In the short run, fixed costs cannot be avoided. In the long run, a company must set its selling price high enough to cover all costs and expenses and generate income.

LO 3 Planning Production In the short run, planning production is limited to existing capacity. In the long run, planning production can consider expanding capacity. Managers often plan and control operations by evaluating the differences between planned and actual contribution margins.

Analyzing Market Segments LO 3 Analyzing Market Segments A market segment is a portion of a business that can be analyzed using sales, costs, and expenses to determine its profitability.

Learning Objective 4 Use variable costing for analyzing market segments, including product, territories, and salespersons segments.

Analyzing Market Segments LO 4 Analyzing Market Segments Camelot Fragrance Company Camelot Fragrance Company manufactures and sells Gwenevere perfume for women and the Lancelot cologne line for men. The company’s data for the month ended March 31, 2012, is shown in the next slide.

Analyzing Market Segments LO 4 Analyzing Market Segments Camelot Fragrance Company

Sales Territory Profitability Analysis LO 4 Sales Territory Profitability Analysis Camelot Fragrance Company Camelot Fragrance Company analyzes its profit differences by sales territory. Contribution Margin Ratio Contribution Margin Sales = Northern Territory: 43% ($34,400/$80,000) Southern Territory: 50.5% ($40,400/$80,000)

Sales Territory Profitability Analysis LO 4 Sales Territory Profitability Analysis Sales mix, sometimes referred to as product mix, is the relative amount of sales among the various products. Camelot Fragrance Company

Learning Objective 5 Use variable costing for analyzing and explaining changes in contribution margin as a result of quantity and price factors.

Contribution Margin Analysis LO 5 Contribution Margin Analysis Contribution margin analysis focuses on explaining the differences between planned and actual contribution margins. A difference between the planned and actual contribution margin may be caused by an increase in: Sales Variable costs

Variable Cost Quantity Factor LO 5 Contribution Margin Analysis Quantity factor is the effect of a difference in the number of units sold, assuming no change in unit sales price or unit cost. Sales Quantity Factor Actual Units Sold Planned Units of Sales Planned Sales Price = – × Variable Cost Quantity Factor Planned Units of Sales Actual Units Sold Planned Unit Cost = – ×

Contribution Margin Analysis LO 5 Contribution Margin Analysis Unit price factor or unit cost factor is the effect of a difference in unit sales price or unit cost on the number of units sold. Unit Price Factor Actual Selling Price per Unit Planned Selling Price per Unit Actual Units Sold = – × Unit Cost Factor Planned Cost per Unit Actual Cost per Unit Actual Units Sold = – ×

Describe and illustrate the use of variable costing for service firms. Learning Objective 6 Describe and illustrate the use of variable costing for service firms.

Variable Costing for Service Firms LO 6 Variable Costing for Service Firms Unlike a manufacturing company, a service company does not make or sell a product. As a result, service companies do not have inventory and, thus, do not allocate fixed costs to inventory using absorption costing concepts.

Variable Costing for Service Firms LO 6 Variable Costing for Service Firms Blue Skies Service firms can report and analyze contribution margin as the difference between revenues and variable costs. To analyze a service firm, we will use Blues Skies Airlines. The fixed and variable costs associated with operating Blue Skies are shown in Exhibit 13 (next slide).

Variable Costing for Service Firms LO 6 Variable Costing for Service Firms Blue Skies

Variable Costing for Service Firms LO 6 Variable Costing for Service Firms Blue Skies The variable costing income statement for Blue Skies Airlines is shown in Exhibit 14 (next slide). Blue Skies Airlines uses the activity base number of passengers for food and beverage service and selling expenses. The company uses number of miles flown for fuel and wages expenses.

Variable Costing for Service Firms LO 6 Variable Costing for Service Firms Blue Skies

Market Segment Analysis for Service Companies LO 6 Market Segment Analysis for Service Companies

Market Segment Analysis for Service Companies LO 6 Market Segment Analysis for Service Companies Blue Skies Blue Skies Airlines

Contribution Margin Analysis LO 6 Blue Skies Contribution Margin Analysis

The End Variable Costing for Management Analysis © 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.