1 Chapter 6 Variable Costing M11-Chp-06-1-Variable-Costing Summer, Edited May 23, Copyright © 2011, Dr. Howard Godfrey Concepts in this chapter are more challenging than those in some prior chapters. Copyright Dr. Howard Godfrey - M11-Chp-06-1-VariableCosting

2 After studying Chap. 6, you should be able to: LO1 Explain how variable costing differs from absorption costing and compute unit product costs under each method. LO2 Prepare income statements using both variable and absorption costing. LO3 Reconcile variable costing and absorption costing net operating incomes and explain why the two amounts differ. LO4 Prepare a segmented income statement that differentiates traceable fixed costs from common fixed costs. Use it to make decisions.

1: Unit product costs

Variable vs Absorption Costing Variable costing excludes fixed manufacturing overhead from inventoriable costs. Absorption costing treats fixed manufacturing overhead as inventoriable costs.

Direct Costing Questions- JV Co. -1 JV Co. began its operations on January 1, and produces a single product that sells for $7.00 per unit. Standard capacity is 100,000 units per year. This year, 100,000 units were produced and 80,000 units were sold. Costs and expenses were as follows: Fixed CostsVariable Costs Raw materials $1.50 per unit produced Direct labor 1.00 per unit produced Factory overhead$150, per unit produced Selling & admin.80, per unit sold There were no variances from the standard variable costs. Unit cost under absorption costing is: a.$2.50. b. $3.00. c. $3.50. d. $4.50. Unit cost under variable costing is: a. $2.50. b. $3.00. c. $3.50. d. $4.50.

Direct Costing Questions-Bates Bates Co. incurred the following costs: Direct materials and direct labor $600,000 Variable factory overhead 80,000 Straight-line depreciation: Production machinery 70,000 Factory building 50,000 Sales office10,000 Under absorption costing, the inventoriable costs are a. $680,000 b. $730,000 c. $750,000 d. $800,000

Direct Costing Questions Using the variable costing method, which of these costs are assigned to inventory? Variable selling andVariable factory administrative costsoverhead costs AYesYes BYesNo CNoNo DNoYes

Charrd Corporation manufactures a gas operated barbecue grill. The following information relates to Charrd's operations for last year: Cost per unit under absorption costing $46 Fixed manufacturing overhead cost$300,000 Fixed selling and administrative cost$125,000 Units (grills) produced and sold25,000 What is Charrd's variable costing unit product cost? A. $29 B. $34 C. $58 D. $63

Consider the handout for Charlotte Corporation. Assume we sell 800 units, not 700 units. No other change. What is the cost of ending inventory with absorption costing?

Cost of ending inventory if we sell 900 units, not 700. Absorption? 1.$3,300 2.$2,200 3.$1,600 4.Other

Cost of ending inventory if we sell 900 units, not 700. Variable cost? 1.$3,300 2.$2,200 3.$1,600 4.Other

2: Prepare income statements

Apex Corporation – 2 of 6

Apex Corporation – 3 of 6

Apex Corporation- 4 of 6 Repeat your computations, except assume that the company uses the absorption costing method.

Apex Corporation – 5 of 6

Apex Corporation – 6 of 6

Gordon Company – 1 of 5

Gordon Company – 2 of 5 You are encouraged to print the following slides – one slide per page (rather than 6 slides per page) so that you can avoid having small print.

Gordon Company – 3 of 5

Gordon Company – 4 of 5

Gordon Company – 5 of 5 Please explain why you obtained different answers with the two different methods?

3: Reconcile net operating incomes

Variable vs. Absorption Costing The differences between variable-costing and absorption-costing methods are based on the treatment of fixed manufacturing overhead.

Reconciliation of Variable Costing and Absorption Costing The difference in income equals the difference in the total amount of fixed manufacturing overhead charged as expense during a given year.

Reconciliation of Variable Costing and Absorption Costing Under absorption costing, fixed overhead appears in the cost of goods sold section of income statement. Under variable costing, fixed overhead is a period cost.

Direct Costing Questions At the end of Killo Co.’s first year of operations, 1,000 units of inventory remained on hand. Variable and fixed manufacturing costs per unit were $90 and $70, respectively. If Killo uses absorption costing rather than variable (direct) costing, the result would be a higher pretax income of a. $0 b. $20,000 c. $70,000 d. $90,000

Direct Costing Questions Fixed manufacturing costs of $70,000 would be reported as part of the cost of ending inventory under the absorption method, but would be shown as part of expense on the income statement under direct costing. This is the first year, so we do not have a difference in the cost of beginning inventory for these two methods.

Effects of Sales & Production on Reported Income Production > Sales Variable costing income is lower than absorption income. Production < Sales Variable costing income is higher than absorption income.

4: Evaluation of methods

Summary Comments The difference between income reported under these two methods is entirely due to the treatment of fixed manufacturing costs Under absorption costing, these costs are treated as assets (inventory) until the associated goods are sold.

Absorption Approach The absorption approach is a costing approach that considers all factory overhead (both variable and fixed) to be product (inventoriable) costs. Factory overhead becomes an expense in the form of manufacturing cost of goods sold only as sales occur.

Contribution Approach In contrast, the contribution approach is used by many companies for internal (management accounting) reporting. It emphasizes the distinction between variable and fixed costs. The contribution approach is not allowed for external financial reporting.

A Company computes net operating income under both the absorption costing approach and the variable costing approach. In the current year the absorption costing net operating income was greater than the variable costing net operating income. This fact suggests that: a. variable manufacturing costs were less than fixed manufacturing costs. b. more units were produced during the year than were sold. c. more units were sold during the year than were produced. d. common costs were greater than variable costs for the year.

The costing method that can be used most easily with break-even analysis and other cost-volume-profit techniques is: a. variable costing. b. absorption costing. c. process costing. d. job-order costing.

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