2. Inventory Costing and Capacity Analysis

3. JOIN KHALID AZIZ ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM. FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA. COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA. CONTACT: 0322-3385752 0312-2302870 R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN

4. Fresh classes of icmap stage 1-3 Fundamentals of fa(1) Cost accounting(2) Financial accounting(3) Cost accounting-appraisal(3) From 22 nd February, 2010

5. FRESH CLASSES OF MA-ECONOMICS PREVIOUS- MICRO ECONOMICS STATISTICS FINAL – MACRO ECONOMICS FROM 15 TH FEBRUARY 2010

6. Learning Objective 1 Identify what distinguishes variable costing from absorption costing.

7. Inventory-Costing Methods The difference between variable costing and absorption costing is based on the treatment of fixed manufacturing overhead.

8. Variable Costing Direct Materials Variable Factory Labor Variable Overhead Work in Process Inventory

9. Variable Costing Work in Process Inventory Finished Goods Inventory Cost of Goods Sold Income Summary Fixed Factory Labor

10. Learning Objective 2 Prepare income statements under absorption costing and variable costing.

11. Comparing Income Statements The following data pertain to Davenport Fixtures: Year 1Year 2 Total Beginning inventory -0- 2,000 -0- Produced10,00011,50021,500 Sold 8,00013,00021,000 Ending inventory 2,000 500 500

12. Comparing Income Statements The following information is on a per unit basis: Sales price:Rs71.00 Variable manufacturing costs: Direct materials:Rs 4.00 Direct manufacturing labor:Rs21.00 Indirect manufacturing costs:Rs24.00 Fixed manufacturing costs:Rs 4.50

13. Comparing Income Statements (Absorption Costing) Total fixed production costs are Rs54,000 at a normal capacity of 12,000 units. Fixed nonmanufacturing costs are Rs30,000 per year. Variable nonmanufacturing costs are Rs2.00 per unit sold.

14. Comparing Income Statements (Absorption Costing) RevenuesRs568,000 Cost of goods sold 428,000 Volume variance (U) 9,000 Gross marginRs131,000 Nonmanufacturing costs 46,000 Operating incomeRs 85,000

15. Comparing Income Statements (Absorption Costing) Revenues for Year 1 are Rs568,000. What is the cost of goods sold? 8,000 × Rs49 = Rs392,000 What is the manufacturing contribution margin? Rs568,000 – Rs392,000 = Rs176,000 Net contribution margin = Rs160,000

16. Comparing Income Statements (Variable Costing) RevenuesRs568,000 Cost of goods sold 392,000 Variable nonmanufacturing costs 16,000 Contribution marginRs160,000 Fixed manufacturing costs 54,000 Fixed nonmanufacturing costs 30,000 Operating incomeRs 76,000

17. Learning Objective 3 Explain differences in operating income under absorption costing and variable costing.

18. Operating Income (Absorption Costing) What are revenues for Year 2? 13,000 × Rs71 = Rs923,000 What is the cost of goods sold? 13,000 × Rs53.50 = Rs695,500 Is there a volume variance? (12,000 – 11,500) × Rs4.50 = Rs2,250 underallocated fixed manufacturing costs

19. Operating Income (Absorption Costing) What is the gross margin? Rs923,000 – (Rs695,500 + Rs2,250) = Rs225,250 What are the nonmanufacturing costs? 13,000 units sold × Rs2.00 = Rs26,000 variable costs + Rs30,000 fixed costs = Rs56,000

20. Operating Income (Absorption Costing) What is the operating income before taxes? Rs225,250 – Rs56,000 = Rs169,250 What is the operating income for the two years combined? Rs85,000 + Rs169,250 = Rs254,250

21. Income Statements (Absorption Costing) Year 1 Year 2 Combined RevenuesRs568,000 Rs923,000 Rs1,491,000 Cost of goods sold 428,000 695,500 1,123,500 Volume variance (U) 9,000 2,250 11,250 Gross marginRs131,000 Rs225,250 Rs 356,250 Nonmfg. costs 46,000 56,000 102,000 Operating incomeRs 85,000 Rs169,250 Rs 254,250

22. Operating Income (Variable Costing) Revenues for Year 2 are Rs923,000. What is the cost of goods sold? 13,000 × Rs49 = Rs637,000 What is the manufacturing contribution margin? Rs923,000 – Rs637,000 = Rs286,000

23. Operating Income (Variable Costing) What is the net contribution margin? Rs286,000 – Rs26,000 variable nonmanufacturing costs = Rs260,000 net contribution margin What is the operating income before taxes? Rs260,000 – Rs54,000 fixed manufacturing costs – Rs30,000 fixed nonmanufacturing costs = Rs176,000

24. Income Statements (Variable Costing) Year 1 Year 2 Combined RevenuesRs568,000Rs923,000Rs1,491,000 Cost of goods sold 392,000 637,000 1,029,000 Mfg. contr. marginRs176,000Rs286,000Rs 462,000 Variable nonmfg. 16,000 26,000 42,000 Net contr. marginRs160,000Rs260,000Rs 420,000

25. Income Statements (Variable Costing) Year 1 Year 2Combined Net contr. marginRs160,000Rs260,000Rs420,000 Fixed mfg. costs 54,000 54,000108,000 Fixed nonmfg. costs 30,000 30,000 60,000 Operating incomeRs 76,000Rs176,000Rs252,000

26. Comparison of Variable and Absorption Costing Variable costing operating income Year 1: Rs76,000 Absorption costing operating income Year 1: Rs85,000 Absorption costing operating income is Rs9,000 higher. Why?

27. Comparison of Variable and Absorption Costing Production exceeds sales in Year 1. The 2,000 units in ending inventory are valued as follows: Absorption costing: 2,000 × Rs53.50 =Rs107,000 Variable costing: 2,000 × Rs49.00 =Rs 98,000 Difference:Rs 9,000

28. JOIN KHALID AZIZ ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM. FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA. COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA. CONTACT: 0322-3385752 0312-2302870 R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN

29. Comparison of Variable and Absorption Costing Variable costing operating income Year 2: Rs176,000 Absorption costing operating income Year 2: Rs169,250 Variable costing operating income is Rs6,750 higher. Why?

30. Comparison of Variable and Absorption Costing Sales exceeded units produced in Year 2. 13,000 – 11,500 = 1,500 decrease in inventory Absorption costing: 1,500 × Rs53.50 = Rs80,250 Variable costing: 1,500 × Rs49.00 = Rs73,500 Higher cost of goods sold under absorption costing: Rs 6,750

31. Comparison of Variable and Absorption Costing Variable costing combined net income: Rs252,000 Absorption costing combined net income: Rs254,250 Absorption costing is higher by Rs2,250 500 units in inventory × Rs4.50 = Rs2,250

32. Comparison of Variable and Absorption Costing Absorption costing operating income Variable costing operating income Fixed manufacturing costs in ending inventory under absorption costing Fixed manufacturing costs in beginning inventory under absorption costing – EQUALS –

33. Learning Objective 4 Understand how absorption costing can provide undesirable incentives for managers to build up finished goods inventory.

34. Inventory Buildup What is the production volume variance? (12,000 – 4,400) × Rs4.50 = Rs34,200 U What is the net operating income or loss for the period? Assume that Davenport Fixtures produced 4,400 units in Year 1 and sold 4,100.

35. Inventory Buildup Revenues (4,100 × Rs71)Rs291,100 Cost of goods sold (4,100 × Rs53.50) 219,350 Volume variance 34,200 Gross marginRs 37,550 Nonmanufacturing costs 38,200 Net lossRs 650

36. Inventory Buildup 4,400 – 4,100 = 300 How much cost is in ending inventory? 300 × Rs53.50 = Rs16,050 How many units are in ending inventory?

37. Inventory Buildup Sales remain the same (4,100 units). What is the volume variance? (12,000 – 9,000) × Rs4.50 = Rs13,500 U Suppose that management decides to produce 9,000 units next year. What is the operating income or loss?

38. Inventory Buildup Revenues (4,100 × Rs71)Rs291,100 Cost of goods sold (4,100 × Rs53.50) 219,350 Volume variance 13,500 Gross margin Rs 58,250 Nonmanufacturing costs 38,200 Net incomeRs 20,050

39. Inventory Buildup 300 + 9,000 – 4,100 = 5,200 How much cost is in ending inventory? 5,200 × Rs53.50 = Rs278,200 How many units are in ending inventory?

40. Learning Objective 5 Differentiate throughput costing from variable costing and absorption costing.

41. Throughput Costing RevenuesRs568,000 Variable direct materials cost of goods sold 32,000 Throughput contribution marginRs536,000 Manufacturing costs 504,000 Nonmanufacturing costs 46,000 Operating lossRs 14,000

42. Throughput Costing Manufacturing Costs: Labor Rs21.00 × 10,000Rs210,000 Indirect costs Rs24.00 × 10,000 240,000 Fixed costs 54,000 Total manufacturing costsRs504,000 What are other nonmanufacturing costs for the year?

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44. Throughput Costing Nonmanufacturing Costs: Variable Rs2.00 × 8,000Rs16,000 Fixed 30,000 TotalRs46,000

45. Throughput Costing Variable costing operating income:Rs76,000 Throughput costing operating loss:Rs14,000 Difference in operating income:Rs90,000 How can this difference be explained?

46. Throughput Costing The 2,000 units in ending inventory are valued as follows: Variable 2,000 × Rs49 = Rs98,000 Throughput 2,000 × Rs4 = Rs8,000 Rs90,000 difference

47. Throughput Costing Absorption costing operating income:Rs85,000 Throughput costing operating loss:Rs14,000 Difference in operating income:Rs99,000 How can this difference be explained?

48. Throughput Costing The 2,000 units in ending inventory are valued as follows: Absorption 2,000 × Rs53.50 = Rs107,000 Throughput 2,000 × Rs4 = Rs8,000 Rs99,000 difference

49. Comparison of Inventory Costing Methods Actual Costing Absorption Costing Absorption Costing Throughput Costing Throughput Costing Variable Costing Variable Costing

50. Comparison of Inventory Costing Methods Normal Costing Absorption Costing Absorption Costing Throughput Costing Throughput Costing Variable Costing Variable Costing

51. Comparison of Inventory Costing Methods Standard Costing Absorption Costing Absorption Costing Throughput Costing Throughput Costing Variable Costing Variable Costing

52. Learning Objective 6 Describe the various capacity concepts that can be used in absorption costing.

53. Alternative Denominator-Level Concepts Theoretical capacity Practical capacity Normal capacity Master-budget capacity

54. Budgeted Fixed Manufacturing Overhead Rate RUSTAMs Bicycles produces bicycle parts for domestic and foreign markets. Fixed overhead costs are Rs200,000 within the relevant range of the various capacity volume.

55. Budgeted Fixed Manufacturing Overhead Rate Assume that the theoretical capacity is 10,000 machine-hours, practical capacity is 85%, normal capacity is 75%, and master-budget capacity is 60%. What is the budgeted fixed manufacturing overhead rate at the various capacity levels?

56. Budgeted Fixed Manufacturing Overhead Rate Theoretical 100%: Rs200,000 ÷ 10,000 = Rs20.00/machine-hour Practical 85%: Rs200,000 ÷ 8,500 = Rs23.53/machine-hour Normal 75%: Rs200,000 ÷ 7,500 = Rs26.67/machine-hour Master-budget 60%: Rs200,000 ÷ 6,000 = Rs33.33/machine-hour

57. Learning Objective 7 Understand the major factors management considers in choosing a capacity level to compute the budgeted fixed overhead cost rate.

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59. Choosing a Capacity Level What factors are considered in choosing a capacity level? Product costing Pricing decision Performance evaluation Financial statements Regulatory requirements Difficulty

60. Decision Making Assume that RUSTAMs Bicycles standard hours are 2 hours per unit. What is the budgeted fixed manufacturing overhead cost per unit?

61. Decision Making Theoretical capacity: Rs20 × 2 = Rs40.00 Practical capacity: Rs23.53 × 2 = Rs47.06 Normal capacity: Rs26.67 × 2 = Rs53.34 Master-budget capacity: Rs33.33 × 2 = Rs66.66

62. Learning Objective 8 Describe how attempts to recover fixed costs of capacity may lead to price increases and lower demand.

63. Downward Demand Spiral The downward demand spiral is the continuing reduction in demand that occurs when the prices of competitors are not met and demand drops.

64. Learning Objective 9 Explain how the capacity level chosen to calculate the budgeted fixed overhead cost rate affects the production-volume variance.

65. Effect on Financial Statements Assume that RUSTAMs Bicycles actually used 8,400 machine-hours during the year. What is the production volume variance?

66. Production Volume Variance Production volume variance = (Denominator level – Actual level) × Budgeted fixed manufacturing overhead rate Theoretical capacity: (10,000 – 8,400) × Rs20.00 = Rs32,000 U Practical capacity: (8,500 – 8,400) × Rs23.53 = Rs2,353 U

67. Production Volume Variance Normal capacity: (7,500 – 8,400) × Rs26.67 = Rs24,003 Master-budget capacity: (6,000 – 8,400) × Rs33.33 = Rs79,992

68. JOIN KHALID AZIZ ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM. FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA. COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA. CONTACT: 0322-3385752 0312-2302870 R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN