Financial and Managerial Accounting Wild, Shaw, and Chiappetta Fourth Edition Wild, Shaw, and Chiappetta Fourth Edition McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 19 Variable Costing and Performance Reporting

Conceptual Learning Objectives C1: Describe how absorption costing can result in over-production. C2: Explain the role of variable costing in pricing special orders. 19-3

A1: Compute and interpret breakeven volume in units. Analytical Learning Objectives 19-4

P1: Compute unit cost under both absorption and variable costing. P2: Prepare and analyze an income statement using absorption costing and using variable costing. P3: Prepare a contribution margin report. P4: Convert income under variable costing to the absorption cost basis. Procedural Learning Objectives 19-5

Absorption costing (also called full costing), assumes that products absorb all costs incurred to produce them. While widely used for financial reporting (GAAP), this costing method can result in misleading product cost information for business decisions. Absorption costing (also called full costing), assumes that products absorb all costs incurred to produce them. While widely used for financial reporting (GAAP), this costing method can result in misleading product cost information for business decisions. Absorption Costing & Variable Costing C1 19-6

Absorption Costing & Variable Costing Under variable costing, only costs that change in total with changes in production level are included in product costs. C2 19-7

Distinguishing Between Absorption Costing and Variable Costing: Absorption Costing Absorption Costing Direct Materials Direct Labor Variable Overhead Fixed Overhead Product Cost P1 19-8

Distinguishing Between Absorption Costing and Variable Costing: Variable Costing Variable Costing Direct Materials Direct Labor Variable Overhead Fixed Overhead Product CostPeriod Cost P1 19-9

Difference Between Absorption Costing and Variable Costing: Computing Unit Cost P

Difference Between Absorption Costing and Variable Costing: Computing Unit Cost P

Analysis of Income Reporting for Both Absorption and Variable Costing P

Analysis of Income Reporting for Absorption Costing: Units Produced Equal Units Sold P2 Notice that the net income is $580,

Analysis of Income Reporting for Variable Costing: Units Produced Equal Units Sold P

Analysis of Income Reporting for Variable Costing: Units Produced Equal Units Sold P2 We can see that the income under variable costing is also $580,000. This is because the number of units produced are equal to the number of units sold

Analysis of Income Reporting for Both Absorption and Variable Costing: Units Produced Equal Units Sold A

Analysis of Income Reporting for Absorption Costing: Units Produced Exceed Units Sold P

Analysis of Income Reporting for Absorption Costing: Units Produced Exceed Units Sold P2 Income for 2010 is $320,

Analysis of Income Reporting for Variable Costing: Units Produced Exceed Units Sold P

Analysis of Income Reporting for Variable Costing: Units Produced Exceed Units Sold P2 Under variable costing, the net income is only $120,

Analysis of Income Reporting for Variable Costing: Units Produced Exceed Units Sold P2 Under absorption costing,$200,000 of fixed overhead is allocated to the 20,000 units in ending inventory and is not expensed until future periods. Variable costing expenses the entire $600,000 of fixed overhead

Analysis of Income Reporting for Both Absorption and Variable Costing: Units Produced Exceed Units Sold P

Analysis of Income Reporting for Absorption Costing: Units Produced Are Less Than Units Sold P2 Income is now $840,

Analysis of Income Reporting for Variable Costing: Units Produced Are Less Than Units Sold P2 Income under variable costing is $1,040,

Analysis of Income Reporting for Both Absorption and Variable Costing: Units Produced Are Less Than Units Sold P

Income Reporting Summarized P

Planning Production C1 Producing too much inventory Excess inventory Higher storage and financing costs Greater risk of obsolescence Producing too little inventory Lost sales Customer dissatisfaction 19-27

Planning Production C

Planning Production: Income Under Absorption Costing for Different Production Levels C1 Exhibit

Planning Production: Income Under Absorption Costing for Different Production Levels C1 Exhibit

Planning Production: Income Under Absorption Costing for Different Production Levels C1 Why is income under absorption costing affected by the production level when that for variable costing is not? The answer lies in the different treatment of fixed overhead costs for the two method

Setting Prices Over the Long Run: Price must be high enough to cover all costs, including variable costs and fixed costs, and still provide an acceptable return to owners C

Setting Prices Over the Short Run: Fixed production costs such as the cost to maintain plant capacity do not change with changes in production levels. With excess capacity, increases in production level would increase variable production costs, but not fixed costs. While managers try to maintain the long-run price on existing orders, which covers all production costs, managers should accept special orders provided the special order price exceeds variable cost. C

Setting Prices C

Contribution Margin Report P3 Contribution margin is the excess of sales over total variable expenses Contribution margin contributes to covering fixed costs and earning income 19-35

Contribution Margin Report P3 The Contribution Margin Ratio is contribution margin divided by sales 19-36

Limitations of Reports Using Variable Costing P3 Absorption costing is almost exclusively used for external reporting (GAAP). For income tax purposes, absorption costing is the only acceptable basis for filings with the Internal Revenue Service (IRS) under the Tax Reform Act of Absorption costing is the only acceptable basis for both external reporting and tax reporting

Converting Reports Under Variable Costing to Absorption Costing P

Calculating Break-Even We can use the data in the following contribution margin format for IceAge to help us determine break-even point. A

Calculating Break-Even Break-Even Volume in Units = Total Fixed Costs Contribution Margin per Unit Where: Contribution margin per unit = Sales price per unit – Variable cost per unit A

Calculating Break-Even A1 Precision Tech’s Break-Even Volume in Units Total fixed costs CM per unit = $800,000 $23 per unit = 34,783 units 19-41

End of Chapter