Variable and Full Costing Managerial Accounting Prepared by Diane Tanner University of North Florida Chapter 3

Measuring Product Costs  Includes all costs necessary to get products ready to sell  Two methods to determine product costs  Full (absorption) costing  Required for GAAP reporting  Emphasizes the cost function  Variable costing  Used for internal decision making  Emphasizes cost behavior 2 Helps managers make product decisions as it is easy to predict how costs will behave in the future

Reporting Product Costs  Merchandising companies  Buy goods to sell  Product costs reported  Merchandise Inventory on the balance sheet  Cost of Goods Sold on the income statement  Manufacturing companies  Buy materials to produce products to sell  Product costs reported  Raw Materials, Work in Process, Finished Goods on the balance sheet  Cost of Goods Sold on the income statement 3

Components of Product Costs 4  Inventoriable costs include  Direct materials  Direct labor  Variable manufacturing overhead costs  Fixed manufacturing overhead costs Full Costing Variable Costing  Inventoriable costs include  Direct materials  Direct labor  Variable manufacturing overhead costs

5 Two Forms of Income Statements 5 Gross margin is the amount available to cover operating expenses and to go towards profit.  Full costing income statement  Costs are reported based on function  Product versus period  Variable costing income statement  Costs are reported based on behavior  Variable versus fixed Contribution margin is the amount available to cover fixed costs and to go towards profit.

GP Ratio vs. CM Ratio Gross Profit (in $) Sales (in $) Indicates the portion of every sales dollar available to cover operating costs and to go towards profit Contribution Margin (in $) Sales (in $) Indicates the portion of every sales dollar available to cover fixed costs and to go towards profit 6 Interpretation

Expanded GAAP Income Statement 7 Sales$100,000 Cost of goods sold: Variable product costs$22,000 Fixed product costs11,000 Total cost of goods sold33,000 Gross margin (gross profit)67,000 Operating expenses: Variable period costs38,000 Fixed period costs19,000 Total operating expenses57,000 Net operating income$10,000 $67,000 $100,000 Gross profit Sales == 67.00%

Expanded Variable Costing Income Statement 8 Sales$100,000 Variable costs: Variable product costs$22,000 Variable period costs38,000 Total variable costs60,000 Contribution margin40,000 Fixed expenses: Fixed product costs11,000 Fixed period costs19,000 Total fixed expenses30,000 Net operating income$10,000 $40,000 $100,000 Contribution Margin Sales == 40.00%

The Contribution Approach 9 Consider the following information developed by the accountant at Element Skateboard Co: For each additional skateboard sold, profit will increase by $200. Fixed costs in total do not change. For each sales dollar generated by Element, profit will increase by $0.40. Fixed costs in total do not change. CMR: = $200/$500 = 40%

10 The End