1. CHAPTER 14: MEASURING AND ASSIGNING COSTS FOR INCOME STATEMENTS Cost Management, Canadian Edition © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 1

2. Learning Objectives © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 2 Q1: How are absorption costing income statements constructed? Q2: How are variable costing income statements constructed? Q3: What factors affect the choice of production volume measures for allocating fixed overhead? Q4: How are throughput costing income statements constructed? Q5: What are the uses and limitations of absorption, variable, and throughput costing income statements?

3. © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide 3 Q1: How are absorption costing income statements constructed?

4. Absorption Costing Income Statements © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 4 Under absorption costing, fixed manufacturing overhead is an inventoriable cost. GAAP requires the use of absorption costing. Absorption costing income statements are prepared using the traditional format. –Expenses are grouped by function. –Manufacturing costs deducted above the gross margin subtotal. –Nonmanufacturing costs deducted below the gross margin subtotal.

5. Absorption Costing Income Statement Example Russell Corporation produces a product that sells for $10. In 2009, there were 10,000 units in beginning finished goods inventory that had a per unit cost of $4.45. The company expected to produce, and actually did produce, 80,000 units, and 62,000 units were sold. The costs incurred in 2009 are shown below. Given the cost information below, compute the inventoriable costs per unit under absorption costing. © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 5

6. Absorption Costing Income Statement Example Suppose that the Russell Corporation uses the FIFO inventory method. Prepare an absorption costing income statement for 2009. © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 6 Note that cost of goods sold is based on the 2009 per-unit manufacturing costs because: (1) Cost per unit was the same in 2008 and 2009. If cost had been different in 2008, 10,000 of the 62,000 units sold would be recorded at the per unit cost in 2008

7. © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide 7 Q2: How are variable costing income statements constructed?

8. Variable Costing Income Statements © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 8 Under variable costing, fixed manufacturing overhead is a period cost. Variable costing income statements are used internally only. Variable costing income statements are prepared using the contribution format. –Expenses are grouped by cost behaviour. –Variable costs deducted above the contribution margin subtotal. –Fixed costs deducted below the contribution margin subtotal.

9. Variable Costing Income Statement Example Russell Corporation produces a product that sells for $10. In 2009, there were 10,000 units in beginning finished goods inventory, with a per unit variable cost of $3.20. The company expected to produce, and actually did produce, 80,000 units, and 62,000 units were sold. The costs incurred in 2009 are shown below. Compute the inventoriable costs per unit under variable costing. © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 9

10. Variable Costing Income Statement Example Suppose that the Russell Corporation uses the FIFO inventory method. Prepare a variable costing income statement for 2009. © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 10 Note that per unit cost was the same in 2008 and 2009 which is why COGS did not factor in separate costs for the 10,000 2008 units and the 52,000 2005 units.

11. Variable Costing Income Statement Example Suppose that the Russell Corporation uses the FIFO inventory method. Reconcile the income under variable costing you determined on the prior slide with the $218,300 income under absorption costing computed on slide #4. © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 11 Variable costing income$195,800 Add: fixed overhead attached to the increase in inventory (18,000 units x $1.25/unit) 22,500 Absorption costing income $218, 300

12. © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide 12 Q3: What factors affect the choice of production volume measures for allocating fixed overhead?

13. Actual versus Estimated Denominator Levels © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 13 Normal costing (chapter 5) uses an estimated, rather than an actual, denominator level for the overhead cost allocation base. If an actual denominator level is used, information is not timely. Using an estimated denominator level provides a smoothing effect, for two reasons: –Numerator reason –Denominator reason

14. Various Measures of Production Volume © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 14 Supply-based measures of capacity: –The maximum possible capacity, with no allowance for downtime, is known as theoretical capacity. –Theoretical capacity, reduced by an allowance for normal downtime, is known as practical capacity. Demand-based measures of capacity: –The average use of capacity of several years is known as normal capacity. –The anticipated use of capacity for the upcoming year is known as budgeted capacity or expected capacity.

15. Effect of Denominator Volume on the Income Statement © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 15 When denominator volume is different than actual volume, there is a fixed overhead volume variance. The volume variance is the difference between budgeted fixed overhead and applied fixed overhead. If material, the volume variance is closed to work in process, finished goods, and cost of goods sold at year-end.

16. Absorption Costing Income Statement & Volume Variance Example Russell Corporation produces a product that sells for $10. In 2009, there were 10,000 units in beginning finished goods inventory. The company expected to produce 100,000 units in 2009. However, it actually produced 80,000 units and sold 62,000 units. The costs incurred in 2009 are shown below. Compute the inventoriable costs per unit under absorption costing. © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 16 Note that choice of denominator level affects only the fixed overhead cost per unit.

17. Absorption Costing Income Statement & Volume Variance Example Suppose that the Russell Corporation uses the FIFO inventory method and that the volume variance is considered material. Assume that the balances in WIP, FG, and CGS, before any adjustment for the volume variance, were at a ratio of 1:2:7 at 12/31/09. There was no fixed overhead spending variance in 2009. Compute the volume variance and prepare the year-end entry to close the fixed overhead control account. © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 17 Note that the unfavourable volume variance equals the underapplied fixed overhead because there was no spending variance for fixed overhead. Budgeted fixed overhead $100,000 Fixed overhead applied (80,000 units x $1/unit) 80,000 Unfavourable fixed overhead volume variance $20,000 Fixed overhead control20,000 Work in process [(1/10) x 20,000]2,000 Finished goods [(2/10) x 20,000]4,000 Cost of good sold [(7/10) x 20,000]14,000

18. Absorption Costing Income Statement & Volume Variance Example Using the cost information on slide #8 and the volume variance you calculated on the prior slide, prepare an absorption costing income statement for 2009. © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 18

19. © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide 19 Q4: How are throughput costing income statements constructed?

20. Throughput Costing Income Statements © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 20 Under throughput costing, all manufacturing costs except direct materials are period costs. Throughput costing income statements are used internally only; useful when most manufacturing costs are not variable in the short run. Throughput costing income statements are prepared using a new format. –Sales – cost of goods sold (direct materials only) = throughput margin

21. Throughput Costing Income Statement Example Russell Corporation produces a product that sells for $10. In 2009, there were 10,000 units in beginning finished goods inventory with per unit costs that were the same as those experienced in 2009. The company expected to produce, and actually did produce, 80,000 units, and 62,000 units were sold. The costs incurred in 2009 are shown below. Suppose that the Russell Corporation uses the FIFO inventory method. Prepare a throughput costing income statement for 2009. © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 21 Note that DL and VO costs expensed based on units produced, not units sold

22. Throughput Costing Income Statement Example continued Reconcile the income under throughput costing you computed on the prior slide to the income under variable costing computed on slide #8 and to the income under absorption costing computed on slide #5. © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 22 Throughput costing income $151,700 Add: Costs attached to the increase in inventory: Direct labor (18,000 units x $1.60/unit) 28,800 Variable overhead (18,000 units x $0.85/unit) 15,300 Variable costing income$195,800 Add: fixed overhead attached to the increase in inventory (18,000 units x $1.25/unit) 22,500 Absorption costing income $218, 300 Throughput costing income $151,700 Add: Costs attached to the increase in inventory: Direct labour (18,000 units x $1.60/unit) 28,800 Variable overhead (18,000 units x $0.85/unit) 15,300 Variable costing income$195,800 Add: fixed overhead attached to the increase in inventory (18,000 units x $1.25/unit) 22,500 Absorption costing income $218, 300

23. © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide 23 Q5: What are the uses and limitations of absorption, variable, and throughput costing income statements?

24. Uses and Limitations of the Three Income Statement Methods © John Wiley & Sons, 2009 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al Slide # 24 Absorption costing is used for external reporting but may not be best for performance evaluation purposes. Variable and throughput costing avoid incentives to build up inventory levels. Throughput costing may be useful for some short- term decision making. Under absorption costing, if practical capacity is used as the denominator level, –the fixed overhead rate is a useful measure of the cost of capacity, and –the volume variance helps measure the use of capacity.

25. Copyright Copyright © 2009 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein. © John Wiley & Sons, 2009Slide 25 Chapter 14: Measuring and Assigning Costs for Income Statements Cost Management, Cdn Ed, by Eldenburg et al