1. Inventory Costing and Capacity Analysis
Chapter 9
Inventory Costing and Capacity Analysis

2. Introduction
The reported income number captures the attention of managers in a way few other numbers do.
This chapter examines two types of cost accounting choices in which the reported income number of manufacturing companies is affected by inventories.
Variable costing and absorption costing
methods treat fixed manufacturing overhead differently:
Under variable costing, fixed manufacturing overhead costs are excluded from inventoriable costs and are a cost of the period in which they are incurred.
Under absorption costing, these costs are inventoriable and become expenses only when a sale occurs.
Under both methods all nonmanufacturing costs in the value chain (such as research and development and marketing), whether variable or fixed, are recorded as expenses when incurred.

3. Variable Overhead Variable Costing
All variable manufacturing costs are assigned to production and they become part of the unit cost.
Fixed costs are charged to the Income Summary
Direct Material Inventory
Payroll Work-in-Process Inventory Variable factory labor
Variable Overhead

4. Variable Costing Payroll Work-in-Process Inventory Fixed factory labor
Income Summary Finished Goods
Cost of Goods Sold
Absorption costing

5. Comparison of Variable and Absorption Costing
Inventory values are smaller with variable costing because it capitalizes only variable cost as asset.
Inventory values using absorption costing have an additional fixed factory overhead per unit
Income in periods of increasing (decreasing) inventory are higher (lower) with absorption costing than with variable 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

6. Inventory Buildup
Absorption costing enables a manager to increase operating income in a specific period by increasing the production schedule, even if there is no customer demand for the additional production.
While the utilized part of fixed costs is inventoried, production volume variance is not. Reducing volume variance by producing to inventory reduces a loss due to low demand
loss is shifted to the future unless demand rises
Cost in inventory
fixed cost in inventory

7. Undesirable effects of producing for inventory
Production of items that absorb minimal fixed manufacturing costs may be delayed.
A plant manager may accept a particular order to increase production even though another plant in the same company is better suited to handle that order.
A plant manager may defer maintenance.

8. Revising Performance Evaluation
Budget carefully and use inventory planning.
Discontinue the use of absorption costing for internal reporting and instead use variable costing.
Incorporate a carrying charge for inventory.
Lengthen the time period used to evaluate performance
Include nonfinancial as well as financial variables in the measures used to evaluate performance.
Sales in units this period ÷ Ending inventory in units this period
Ending inventory in units this period ÷ Ending inventory in units last period

9. Throughput Costing...
treats all costs except those related to variable direct materials as period costs.
Only direct materials costs are inventoriable costs.
Inventoriable costs
absorption costing
variable costing
Throughput costing
Reported loss
absorption costing
variable costing
Throughput costing
Flexible cost budget
loss
Revenue,
both periods
sales volume
production volume

10. Comparison of Inventory Costing Methods
Actual
or Normal
or Standard
Costing
Variable
Costing
Absorption
Costing
Throughput
Costing

11. Alternative Denominator-Level Concepts
The choice of the denominator used to allocate budgeted fixed manufacturing costs to products can greatly affect the numbers a normal or standard (absorption) costing system will report prior to the end of an accounting period.
Alternative Denominator-Level Concepts
Theoretical capacity xt (maximum or ideal capacity)
based on producing at full (peak) efficiency all the time.
Practical capacity xp
reduces theoretical capacity by unavoidable operating interruptions
The use of practical capacity is required by the IRS.
Normal capacityxn
based on the level of capacity utilization that satisfies average customer demand over several periods
includes seasonal, cyclical, and trend factors.
Master-budget capacity xm
based on the expected level of capacity utilization for the next budget period (typically one year).

12. Budgeted Fixed Manufacturing Overhead Rate
for xt
negative volume variance
Budgeted Fixed cost
volume variance for
normal capacity
volume variance for xp
Slope = fixed overhead rate
xm xn xp xt xa

13. Decision Making
Cost data from a normal or standard costing system are often used in pricing or product-emphasis decisions.
Downward Demand Spiral
The use of normal capacity utilization or master-budget capacity utilization can result in capacity costs being spread over a small number of output units.
Downward demand spiral: continuing reduction in demand that occurs when the prices of competitors are not met and demand drops. f2 f1 D2 D1

14. CCs for chapter 9 9-21 (3%) 9-23 (5%) 9-33 (3%) 9-17 (5%) 9-19 (5%)
9-25 (= )(3%)
9-37 (10%)
9-41 (10%) (new in 12)
If not otherwise indicated problems identical to 11th ed.
Please explain the problem statement, give the data, and explain your solution. Mere results will not yield satisfactory grade.

15. Data 9-37 Denominator level choice
Standard for Actual units of output:
Budgeted fixed overhead: $
at practical capacity:
fixed manuf. overhead spending variance: (U)
production volume variance: $ (U)
at normal capacity:
production volume variance: $ (F)