1. Inventory Costing and Capacity Analysis
Cost Management (Horngren)
Chapter 9
Inventory Costing and Capacity Analysis
Chapter 9

2. Cost Management (Horngren)
Chapter 9
Learning Objective 1
Identify what distinguishes
variable costing from
absorption costing.

3. Inventory-Costing Methods
Cost Management (Horngren)
Chapter 9
Inventory-Costing Methods
The difference between variable costing
and absorption costing is based on the
treatment of fixed manufacturing overhead.

4. Cost Management (Horngren)
Chapter 9
Variable Costing
Direct
Materials
Variable
Factory
Labor
Variable
Overhead
Work in Process Inventory

5. Cost Management (Horngren)
Chapter 9
Variable Costing
Work in Process
Inventory
Finished Goods
Inventory
Fixed Factory
Labor
Cost of Goods Sold
Income Summary

6. Cost Management (Horngren)
Chapter 9
Learning Objective 2
Prepare income statements
under absorption costing
and variable costing.

7. Comparing Income Statements
Cost Management (Horngren)
Chapter 9
Comparing Income Statements
The following data pertain to Davenport Fixtures:
Year 1 Year 2 Total
Beginning inventory ,
Produced 10,000 11,500 21,500
Sold ,000 13,000 21,000
Ending inventory 2,

8. Comparing Income Statements
Cost Management (Horngren)
Chapter 9
Comparing Income Statements
The following information is on a per unit basis:
Sales price: $71.00
Variable manufacturing costs:
Direct materials: $ 4.00
Direct manufacturing labor: $21.00
Indirect manufacturing costs: $24.00
Fixed manufacturing costs: $ 4.50

9. Comparing Income Statements (Absorption Costing)
Cost Management (Horngren)
Chapter 9
Comparing Income Statements (Absorption Costing)
Total fixed production costs are $54,000
at a normal capacity of 12,000 units.
Fixed nonmanufacturing costs are
$30,000 per year.
Variable nonmanufacturing costs are
$2.00 per unit sold.

10. Comparing Income Statements (Absorption Costing)
Cost Management (Horngren)
Chapter 9
Comparing Income Statements (Absorption Costing)
Revenues $568,000
Cost of goods sold ,000
Volume variance (U) ,000
Gross margin $131,000
Nonmanufacturing costs ,000
Operating income $ 85,000

11. Comparing Income Statements (Variable Costing)
Cost Management (Horngren)
Chapter 9
Comparing Income Statements (Variable Costing)
Revenues for Year 1 are $568,000.
What is the variable cost of goods sold?
8,000 × $49 = $392,000
What is the manufacturing contribution margin?
$568,000 – $392,000 = $176,000
Net contribution margin = $160,000

12. Comparing Income Statements (Variable Costing)
Cost Management (Horngren)
Chapter 9
Comparing Income Statements (Variable Costing)
Revenues $568,000
Variable cost of goods sold ,000
Variable nonmanufacturing costs ,000
Contribution margin $160,000
Fixed manufacturing costs ,000
Fixed nonmanufacturing costs ,000
Operating income $ 76,000

13. Cost Management (Horngren)
Chapter 9
Learning Objective 3
Explain differences in operating
income under absorption
costing and variable costing.

14. Operating Income (Absorption Costing)
Cost Management (Horngren)
Chapter 9
Operating Income (Absorption Costing)
What are revenues for Year 2?
13,000 × $71 = $923,000
What is the cost of goods sold?
13,000 × $53.50 = $695,500
Is there a volume variance?
(12,000 – 11,500) × $4.50 = $2,250
underallocated fixed manufacturing costs

15. Operating Income (Absorption Costing)
Cost Management (Horngren)
Chapter 9
Operating Income (Absorption Costing)
What is the gross margin?
$923,000 – ($695,500 + $2,250) = $225,250
What are the nonmanufacturing costs?
13,000 units sold × $2.00 = $26,000
variable costs + $30,000 fixed costs = $56,000

16. Operating Income (Absorption Costing)
Cost Management (Horngren)
Chapter 9
Operating Income (Absorption Costing)
What is the operating income before taxes?
$225,250 – $56,000 = $169,250
What is the operating income for the
two years combined?
$85,000 + $169,250 = $254,250

17. Income Statements (Absorption Costing)
Cost Management (Horngren)
Chapter 9
Income Statements (Absorption Costing)
Year Year Combined
Revenues $568,000 $923,000 $1,491,000
Cost of goods sold , , ,123,500
Volume variance (U) , , ,250
Gross margin $131,000 $225, $ 356,250
Nonmfg. costs , , ,000
Operating income $ 85,000 $169,250 $ 254,250

18. Operating Income (Variable Costing)
Cost Management (Horngren)
Chapter 9
Operating Income (Variable Costing)
Revenues for Year 2 are $923,000.
What is the cost of goods sold?
13,000 × $49 = $637,000
What is the manufacturing contribution margin?
$923,000 – $637,000 = $286,000

19. Operating Income (Variable Costing)
Cost Management (Horngren)
Chapter 9
Operating Income (Variable Costing)
What is the net contribution margin?
$286,000 – $26,000 variable nonmanufacturing costs
= $260,000 net contribution margin
What is the operating income before taxes?
$260,000 – $54,000 fixed manufacturing costs
– $30,000 fixed nonmanufacturing costs = $176,000

20. Income Statements (Variable Costing)
Cost Management (Horngren)
Chapter 9
Income Statements (Variable Costing)
Year 1 Year 2 Combined
Revenues $568,000 $923,000 $1,491,000
Cost of goods sold 392, , ,029,000
Mfg. contr. margin $176,000 $286,000 $ 462,000
Variable nonmfg , , ,000
Net contr. margin $160,000 $260,000 $ 420,000
Fixed mfg. costs , , ,000
Fixed nonmfg. costs , , ,000
Operating income $ 76,000 $176,000 $ 252,000

21. Comparison of Variable and Absorption Costing
Cost Management (Horngren)
Chapter 9
Comparison of Variable and Absorption Costing
Variable costing operating income Year 1: $76,000
Absorption costing operating income Year 1: $85,000
Absorption costing operating income is $9,000 higher.
Why?

22. Comparison of Variable and Absorption Costing
Cost Management (Horngren)
Chapter 9
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 × $53.50 = $107,000
Variable costing: 2,000 × $49.00 = $ 98,000
Difference: $ 9,000

23. Comparison of Variable and Absorption Costing
Cost Management (Horngren)
Chapter 9
Comparison of Variable and Absorption Costing
Variable costing operating income Year 2: $176,000
Absorption costing operating income Year 2: $169,250
Variable costing operating income is $6,750 higher.
Why?

24. Comparison of Variable and Absorption Costing
Cost Management (Horngren)
Chapter 9
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 × $53.50 = $80,250
Variable costing: 1,500 × $49.00 = $73,500
Higher cost of goods sold under
absorption costing: $ 6,750

25. Comparison of Variable and Absorption Costing
Cost Management (Horngren)
Chapter 9
Comparison of Variable and Absorption Costing
Variable costing combined net income: $252,000
Absorption costing combined net income: $254,250
Absorption costing is higher by $2,250
500 units in inventory × $4.50 = $2,250

26. Comparison of Variable and Absorption Costing
Cost Management (Horngren)
Chapter 9
Comparison of Variable and Absorption Costing
Absorption costing
operating income –
Variable costing
operating income
EQUALS
Fixed manufacturing
costs in ending
inventory under
absorption costing –
Fixed manufacturing
costs in beginning
inventory under
absorption costing

27. Cost Management (Horngren)
Chapter 9
Learning Objective 4
Understand how absorption
costing can provide undesirable
incentives for managers to
build up finished goods inventory.

28. Cost Management (Horngren)
Chapter 9
Inventory Buildup
Assume that Davenport Fixtures produced
4,400 units in Year 1 and sold 4,100.
What is the production volume variance?
(12,000 – 4,400) × $4.50 = $34,200 U
What is the net operating income or loss
for the period?

29. Cost Management (Horngren)
Chapter 9
Inventory Buildup
Revenues (4,100 × $71) $291,100
Cost of goods sold (4,100 × $53.50) 219,350
Volume variance ,200
Gross margin $ 37,550
Nonmanufacturing costs ,200
Net loss ($ )

30. Cost Management (Horngren)
Chapter 9
Inventory Buildup
How many units are in ending inventory?
4,400 – 4,100 = 300
How much cost is in ending inventory?
300 × $53.50 = $16,050

31. Cost Management (Horngren)
Chapter 9
Inventory Buildup
Suppose that management decides to
produce 9,000 units next year.
Sales remain the same (4,100 units).
What is the volume variance?
(12,000 – 9,000) × $4.50 = $13,500 U
What is the operating income or loss?

32. Cost Management (Horngren)
Chapter 9
Inventory Buildup
Revenues (4,100 × $71) $291,100
Cost of goods sold (4,100 × $53.50) 219,350
Volume variance ,500
Gross margin $ 58,250
Nonmanufacturing costs ,200
Net income $ 20,050

33. Cost Management (Horngren)
Chapter 9
Inventory Buildup
How many units are in ending inventory?
,000 – 4,100 = 5,200
How much cost is in ending inventory?
5,200 × $53.50 = $278,200

34. Reducing Undesirable Effects
Cost Management (Horngren)
Chapter 9
Reducing Undesirable Effects
Careful budgeting procedures
Change in accounting system
Carrying charge for inventory
Longer evaluation period
Nonfinancial measures of performance

35. Cost Management (Horngren)
Chapter 9
Learning Objective 5
Differentiate throughput
costing from variable costing
and absorption costing.

36. Cost Management (Horngren)
Chapter 9
Throughput Costing
Revenues $568,000
Variable direct materials
cost of goods sold ,000
Throughput contribution margin $536,000
Manufacturing costs ,000
Nonmanufacturing costs ,000
Operating loss ($ 14,000)

37. Cost Management (Horngren)
Chapter 9
Throughput Costing
Manufacturing Costs:
Labor $21.00 × 10,000 $210,000
Indirect costs $24.00 × 10, ,000
Fixed costs ,000
Total manufacturing costs $504,000
What are other nonmanufacturing costs for the year?

38. Cost Management (Horngren)
Chapter 9
Throughput Costing
Nonmanufacturing Costs:
Variable $2.00 × 8,000 $16,000
Fixed ,000
Total $46,000

39. Cost Management (Horngren)
Chapter 9
Throughput Costing
Variable costing operating income: $76,000
Throughput costing operating loss: ($14,000)
Difference in operating income: $90,000
How can this difference be explained?

40. Cost Management (Horngren)
Chapter 9
Throughput Costing
The 2,000 units in ending inventory
are valued as follows:
Variable
2,000 × $49 = $98,000
Throughput
2,000 × $4 = $8,000
$90,000 difference

41. Cost Management (Horngren)
Chapter 9
Throughput Costing
Absorption costing operating income: $85,000
Throughput costing operating loss: ($14,000)
Difference in operating income: $99,000
How can this difference be explained?

42. Cost Management (Horngren)
Chapter 9
Throughput Costing
The 2,000 units in ending inventory
are valued as follows:
Absorption
2,000 × $53.50 =
$107,000
Throughput
2,000 × $4
= $8,000
$99,000 difference

43. Comparison of Inventory Costing Methods
Cost Management (Horngren)
Chapter 9
Comparison of Inventory Costing Methods
Actual Costing
Variable
Costing
Absorption
Costing
Throughput
Costing

44. Comparison of Inventory Costing Methods
Cost Management (Horngren)
Chapter 9
Comparison of Inventory Costing Methods
Normal Costing
Variable
Costing
Absorption
Costing
Throughput
Costing

45. Comparison of Inventory Costing Methods
Cost Management (Horngren)
Chapter 9
Comparison of Inventory Costing Methods
Standard Costing
Variable
Costing
Absorption
Costing
Throughput
Costing

46. Cost Management (Horngren)
Chapter 9
Learning Objective 6
Describe the various
capacity concepts
that can be used in
absorption costing.

47. Alternative Denominator-Level Concepts
Cost Management (Horngren)
Chapter 9
Alternative Denominator-Level Concepts
Theoretical capacity
Practical capacity
Normal capacity
Master-budget capacity

48. Budgeted Fixed Manufacturing Overhead Rate
Cost Management (Horngren)
Chapter 9
Budgeted Fixed Manufacturing Overhead Rate
Lloyd’s Bicycles produces bicycle parts
for domestic and foreign markets.
Fixed overhead costs are $200,000 within the
relevant range of the various capacity volume.

49. Budgeted Fixed Manufacturing Overhead Rate
Cost Management (Horngren)
Chapter 9
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?

50. Budgeted Fixed Manufacturing Overhead Rate
Cost Management (Horngren)
Chapter 9
Budgeted Fixed Manufacturing Overhead Rate
Theoretical 100%:
$200,000 ÷ 10,000 = $20.00/machine-hour
Practical 85%:
$200,000 ÷ 8,500 = $23.53/machine-hour
Normal 75%:
$200,000 ÷ 7,500 = $26.67/machine-hour
Master-budget 60%:
$200,000 ÷ 6,000 = $33.33/machine-hour

51. Cost Management (Horngren)
Chapter 9
Learning Objective 7
Understand the major factors
management considers in choosing
a capacity level to compute the
budgeted fixed overhead cost rate.

52. Choosing a Capacity Level
Cost Management (Horngren)
Chapter 9
Choosing a Capacity Level
What factors are considered
in choosing a capacity level?
Product
costing
Pricing
decision
Performance
evaluation
Financial
statements
Regulatory
requirements
Difficulty

53. Cost Management (Horngren)
Chapter 9
Decision Making
Assume that Lloyd’s Bicycles’ standard
hours are 2 hours per unit.
What is the budgeted fixed manufacturing
overhead cost per unit?

54. Cost Management (Horngren)
Chapter 9
Decision Making
Theoretical capacity: $20 × 2 = $40.00
Practical capacity: $23.53 × 2 = $47.06
Normal capacity: $26.67 × 2 = $53.34
Master-budget capacity: $33.33 × 2 = $66.66

55. Cost Management (Horngren)
Chapter 9
Learning Objective 8
Describe how attempts to
recover fixed costs of capacity
may lead to price increases
and lower demand.

56. Downward Demand Spiral
Cost Management (Horngren)
Chapter 9
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.

57. Cost Management (Horngren)
Chapter 9
Learning Objective 9
Explain how the capacity
level chosen to calculate
the budgeted fixed overhead
cost rate affects the
production-volume variance.

58. Effect on Financial Statements
Cost Management (Horngren)
Chapter 9
Effect on Financial Statements
Assume that Lloyd’s Bicycles actually used
8,400 machine-hours during the year.
What is the production volume variance?

59. Production Volume Variance
Cost Management (Horngren)
Chapter 9
Production Volume Variance
Production volume variance
= (Denominator level – Actual level)
× Budgeted fixed manufacturing overhead rate
Theoretical capacity:
(10,000 – 8,400) × $20.00 = $32,000 U
Practical capacity:
(8,500 – 8,400) × $23.53 = $2,353 U

60. Production Volume Variance
Cost Management (Horngren)
Chapter 9
Production Volume Variance
Normal capacity:
(7,500 – 8,400) × $26.67 = $24,003
Master-budget capacity:
(6,000 – 8,400) × $33.33 = $79,992

61. End of Variable Costing
Cost Management (Horngren)
Chapter 9
End of Variable Costing