1. Describe and illustrate income reporting under variable costing and absorption costing. 2. Describe and illustrate income analysis under variable costing and absorption costing. Chapter 19 - Objectives

Two Costing Methods 4 Used for external financial reporting 4 Includes direct materials, direct labor, variable factory overhead, and fixed factory overhead as part of total product cost Absorption Costing Absorption Costing

Two Costing Methods Variable Costing 4 Used for internal planning and decision making 4 Does not include fixed factory overhead as a product cost

Absorption Costing Compared to Variable Costing Variable Costing Absorption Costing Cost of Goods Manufactured DirectMaterialsDirectLaborVariable Factory OH Fixed Period Expense

Variable Costing Income Statement Sales (15,000 x $50)$750,000 Variable cost of goods sold: Variable cost of goods mfg. (15,000 x $25)$375,000 Less ending inventory 0 Variable cost of goods sold 375,000 Manufacturing margin$375,000 Variable selling and administrative expenses (15,000 x $5) 75,000 Contribution margin$300,000 Fixed costs: Fixed manufacturing costs$150,000 Fixed selling and administrative expenses 50, ,000 Income from operations$100,000 Units Manufactured Equal Units Sold

Sales (15,000 x $50) $750,000 Cost of goods sold: Cost of goods manufactured (15,000 x $35) $525,000 Less ending inventory 0 Cost of goods sold 525,000 Gross profit$225,000 Selling and administrative expenses ($75,000 + $50,000) 125,000 Income from operations$100,000 Sales (15,000 x $50) $750,000 Cost of goods sold: Cost of goods manufactured (15,000 x $35) $525,000 Less ending inventory 0 Cost of goods sold 525,000 Gross profit$225,000 Selling and administrative expenses ($75,000 + $50,000) 125,000 Income from operations$100,000 Absorption Costing Income Statement Units Manufactured Equal Units Sold When the number of units manufactured equals the number of units sold, income from operations will be the same under both methods.

Variable Costing Income Statement Sales (12,000 x $50)$600,000 Variable cost of goods sold: Variable cost of goods manufactured (15,000 x $25)$375,000 Less ending inventory (3,000 x $25) 75,000 Variable cost of goods sold 300,000 Manufacturing margin$300,000 Variable selling and admin. expenses 60,000 Contribution margin$240,000 Fixed costs: Fixed manufacturing costs$150,000 Fixed selling and admin. expenses 50, ,000 Income from operations$ 40,000 Units Manufactured Exceed Units Sold

Absorption Costing Income Statement Sales (12,000 x $50)$600,000 Cost of goods sold: Cost of goods manufactured (15,000 x $35)$525,000 Less ending inventory (3,000 x $35) 105,000 Cost of goods sold 420,000 Gross profit$180,000 Selling and administrative expenses [(12,000 x $5) + $50,000] 110,000 Income from operations$ 70,000 Units Manufactured Exceed Units Sold

Operating Income: Absorption costing$70,000 Variable costing 40,000 Difference$30,000 Units Manufactured Exceed Units Sold Why is absorption costing income higher when units manufactured exceed units sold?

Analysis: Units manufactured15,000 Units sold 12,000 Ending inventory units3,000 Fixed cost per unitx $10 Difference$30,000 Units Manufactured Exceed Units Sold Operating Income: Absorption costing$70,000 Variable costing 40,000 Difference$30,000

Sales (15,000 x $50)$750,000 Variable cost of goods sold: Beginning inventory (5,000 x $25)$125,000 Variable cost of goods manufactured (10,000 x $25) 250, ,000 Manufacturing margin$375,000 Variable selling and admin. expenses 75,000 Contribution margin$300,000 Fixed costs: Fixed manufacturing costs$150,000 Fixed selling and admin. expenses 50, ,000 Income from operations$100,000 Units Manufactured Are Less Than Units Sold Variable Costing Income Statement

Sales (15,000 x $50)$750,000 Variable cost of goods sold: Beginning inventory (5,000 x $25)$125,000 Variable cost of goods manufactured (10,000 x $25) 250, ,000 Manufacturing margin$375,000 Variable selling and admin. expenses 75,000 Contribution margin$300,000 Fixed costs: Fixed manufacturing costs$150,000 Fixed selling and admin. expenses 50, ,000 Income from operations$100,000 Units Manufactured Are Less Than Units Sold Variable Costing Income Statement

Sales (15,000 x $50)$750,000 Cost of goods sold: Beginning inventory (5,000 x $35)$175,000 Cost of good manufactured (10,000 x $45) 400,000 Cost of goods sold 575,000 Gross profit$175,000 Selling and administrative expenses ($75,000 + $50,000) 125,000 Income from operations$ 50,000 Absorption Costing Income Statement Units Manufactured Are Less Than Units Sold

Operating Income: Variable costing$100,000 Absorption costing 50,000 Difference$ 50,000 Units Manufactured Are Less Than Units Sold Why is variable costing income higher when units manufactured are less than units sold?

Units Manufactured Are Less Than Units Sold Analysis: Units sold15,000 Units manufactured 10,000 Beginning inventory units5,000 Fixed cost per unit x $10 Difference$50,000 Operating Income: Variable costing$100,000 Absorption costing 50,000 Difference$ 50,000

IF Units Sold < Units produced THEN Variable Costing < Absorption CostingIncome

IF Units Sold > Units produced THEN Variable Costing > Absorption CostingIncome

Income Analysis Under Variable Costing and Absorption Costing Frand Manufacturing Company has no beginning inventory and sales are estimated to be 20,000 units at $75 per unit, regardless of production levels.

Income Analysis Under Variable Costing and Absorption Costing Proposal 1: 20,000 Units to Be Manufactured and Sold Total CostUnit Cost Manufacturing costs: Variable$ 700,000$35 Fixed 400, Total costs$1,100,000$55 Selling and administrative exp. Variable ($5 per unit sold)$ 100,000 Fixed 100,000 Total expenses$ 200,000

Income Analysis Under Variable Costing and Absorption Costing Total CostUnit Cost Manufacturing costs: Variable$ 875,000$35 Fixed 400, Total costs$1,275,000$51 Selling and administrative exp. Variable ($5 per unit sold)$ 100,000 Fixed 100,000 Total expenses$ 200,000 Proposal 2: 25,000 Units to Be Manufactured; 20,000 Units to Be Sold

Frand Manufacturing Company Absorption Costing Income Statements 20,000 Units Manufactured 25,000 Units Manufactured Sales$1,500,000$1,500,000 Cost of goods sold: Cost of goods manufactured (20,000 units x $55)$1,100,000

Frand Manufacturing Company Absorption Costing Income Statements 20,000 Units Manufactured 25,000 Units Manufactured Sales$1,500,000$1,500,000 Cost of goods sold: Cost of goods manufactured (20,000 units x $55)$1,100,000 (25,000 units x $51)$1,275,000

Frand Manufacturing Company Absorption Costing Income Statements 20,000 Units Manufactured 25,000 Units Manufactured Sales$1,500,000$1,500,000 Cost of goods sold: Cost of goods manufactured (20,000 units x $55)$1,100,000 (25,000 units x $51)$1,275,000 Less ending inventory: (5,000 units x $51) 255,000 Cost of goods sold$1,100,000$1,020,000 Gross profit$ 400,000$ 480,000 Selling and administrative expenses ($100,000 + $100,000) 200, ,000 $ 200,000$ 280,000 Income from operations$ 200,000$ 280,000

Frand Manufacturing Company Variable Costing Income Statements 20,000 Units Manufactured 25,000 Units Manufactured Sales$1,500,000$1,500,000 Variable cost of goods sold: Variable cost of goods manufactured: (20,000 units x $35)$ 700,000 (25,000 units x $35)$ 875,000

Frand Manufacturing Company Variable Costing Income Statements 20,000 Units Manufactured 25,000 Units Manufactured Sales$1,500,000$1,500,000 Variable cost of goods sold: Variable cost of goods manufactured: (20,000 units x $35)$ 700,000 (25,000 units x $35)$ 875,000 Less ending inventory: (0 units x $35)0 (5,000 units x $35) 175,000 Variable cost of goods sold$ 700,000$ 700,000 Manufacturing margin$ 800,000$ 800,000 ContinuedContinued

Frand Manufacturing Company Variable Costing Income Statements 20,000 Units Manufactured 25,000 Units Manufactured Manufacturing margin$ 800,000$ 800,000 Variable selling and administrative expenses 100, ,000 Contribution margin$ 700,000$ 700,000 Fixed costs: Fixed manufacturing costs$ 400,000$ 400,000 Fixed selling and administrative expenses 100, ,000 Total fixed costs$ 500,000$ 500,000 Income from operations$ 200,000$ 200,000

Frand Manufacturing Company Variable Costing Income Statements 30,000 Units Manufactured Sales$1,500,000 Variable cost of goods sold: Variable cost of goods manufactured: (30,000 units x $35)$1,050,000 Less ending inventory: (10,000 units x $35) 350,000 Variable cost of goods sold$ 700,000 Manufacturing margin$ 800,000 ContinuedContinued Suppose units were manufactured

Frand Manufacturing Company Variable Costing Income Statements 30,000 Units Manufactured Manufacturing margin$ 800,000 Variable selling and administrative expenses 100,000 Contribution margin$ 700,000 Fixed costs: Fixed manufacturing costs$ 400,000 Fixed selling and administrative expenses 100,000 Total fixed costs$ 500,000 Income from operations$ 200,000

Management’s Use of Costing Methods 1.Controlling costs 2.Pricing products 3.Planning production 4.Analyzing market segments 5.Analyzing contribution margins Variable costing reports and absorption costing reports are useful in the following situations:

Accounting Reports and Management Decisions ACCOUNTING REPORTS Absorption Costing and Variable Costing MANAGEMENT