Topic_Ma04

Chapter 7 : 

Chapter 7 Variable Costing:A Tool for Management

Learning Objective 1 : 

Learning Objective 1 Explain how variable costing differs from absorption costing and compute unit product costs under each method.

Overview of Absorptionand Variable Costing : 

Overview of Absorptionand Variable Costing VariableCosting AbsorptionCosting

Quick Check  : 

Quick Check  Which method will produce the highest values for work in process and finished goods inventories? a. Absorption costing. b. Variable costing. c. They produce the same values for these inventories. d. It depends. . .

Quick Check  : 

Which method will produce the highest values for work in process and finished goods inventories? a. Absorption costing. b. Variable costing. c. They produce the same values for these inventories. d. It depends. . . Quick Check 

Unit Cost Computations : 

Harvey Company produces a single productwith the following information available: Unit Cost Computations

Unit Cost Computations : 

Unit product cost is determined as follows: Under absorption costing, selling and administrative expenses arealways treated as period expenses and deducted from revenue as incurred. Unit Cost Computations

Learning Objective 2 : 

Learning Objective 2 Prepare income statements using both variable and absorption costing.

Income Comparison ofAbsorption and Variable Costing : 

Income Comparison ofAbsorption and Variable Costing Let’s assume the following additional information for Harvey Company. 20,000 units were sold during the year at a price of $30 each. There were no units in beginning inventory. Now, let’s compute net operatingincome using both absorptionand variable costing.

Absorption Costing : 

Absorption Costing

Variable Costing : 

Variable Costing

Learning Objective 3 : 

Learning Objective 3 Reconcile variable costing and absorption costing net operating incomes and explain why the two amounts differ.

Comparing the Two Methods : 

Comparing the Two Methods

Comparing the Two Methods : 

We can reconcile the difference betweenabsorption and variable income as follows: Comparing the Two Methods

Extended Comparisons of Income Data Harvey Company Year Two : 

Extended Comparisons of Income Data Harvey Company Year Two

Unit Cost Computations : 

Unit Cost Computations Since there was no change in the variable costsper unit, total fixed costs, or the number ofunits produced, the unit costs remain unchanged.

Absorption Costing : 

Absorption Costing

Variable Costing : 

Variable Costing

Comparing the Two Methods : 

We can reconcile the difference betweenabsorption and variable income as follows: Comparing the Two Methods

Comparing the Two Methods : 

Comparing the Two Methods

Summary of Key Insights : 

Summary of Key Insights

Effect of Changes in Productionon Net Operating Income : 

Effect of Changes in Productionon Net Operating Income Let’s revise the Harvey Company example. In the previous example,25,000 units were produced each year,but sales increased from 20,000 units in yearone to 30,000 units in year two. In this revised example,production will differ each year whilesales will remain constant.

Effect of Changes in ProductionHarvey Company Year One : 

Effect of Changes in ProductionHarvey Company Year One

Unit Cost Computations for Year One : 

Unit product cost is determined as follows: Unit Cost Computations for Year One

Absorption Costing: Year One : 

Absorption Costing: Year One

Variable Costing: Year One : 

Variable Costing: Year One

Effect of Changes in ProductionHarvey Company Year Two : 

Effect of Changes in ProductionHarvey Company Year Two

Unit Cost Computations for Year Two : 

Unit product cost is determined as follows: Unit Cost Computations for Year Two

Absorption Costing: Year Two : 

Absorption Costing: Year Two

Variable Costing: Year Two : 

Variable Costing: Year Two

Comparing the Two Methods : 

Comparing the Two Methods

Learning Objective 4 : 

Learning Objective 4 Understand the advantages and disadvantages of both variable and absorption costing.

Impact on the Manager : 

Impact on the Manager Opponents of absorption costing argue thatshifting fixed manufacturing overhead costsbetween periods can lead to faulty decisions. These opponents argue that variable costing incomestatements are easier to understand because net operatingincome is only affected by changes in unit sales. Thisproduces net operating income figures that aremore consistent with managers’ expectations.

CVP Analysis, Decision Makingand Absorption costing : 

CVP Analysis, Decision Makingand Absorption costing Absorption costing does not support CVP analysis because it essentially treats fixed manufacturing overhead as a variable cost by assigning a per unit amount of the fixed overhead to each unit of production. Treating fixed manufacturing overhead as a variable cost can: Lead to faulty pricing decisions and keep-or-drop decisions. Produce positive net operating income even when the number of units sold is less than the breakeven point.

External Reporting and Income Taxes : 

External Reporting and Income Taxes To conform toGAAP requirements,absorption costing must be used forexternal financial reports in the United States. Under the TaxReform Act of 1986,absorption costing must beused when filing income tax returns.

Advantages of Variable Costingand the Contribution Approach : 

Advantages of Variable Costingand the Contribution Approach Advantages

Variable versus Absorption Costing : 

Variable versus Absorption Costing

Variable Costing and theTheory of Constraints (TOC) : 

Variable Costing and theTheory of Constraints (TOC) Companies involved in TOC use a form of variable costing. However, one difference of the TOC approach is that it treats direct labor as a fixed cost for three reasons: Many companies have a commitment to guarantee workers a minimum number of paid hours. Direct labor is usually not the constraint. TOC emphasizes the role direct laborers play in driving continuous improvement. Since layoffs often devastate morale, managers involved in TOC are extremely reluctant to lay off employees.

Impact of JIT Inventory Methods : 

Impact of JIT Inventory Methods In a JIT inventory system . . . Productiontends to equalsales . . . So, the difference between variable and absorption income tends to disappear.

End of Chapter 7 : 

End of Chapter 7