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absorption and variable costing

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absorption and variable costing

absorption and variable costing

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    • 1. Chapter 8 Absorption and Variable CostingMcGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
    • 2. Learning Objective 1McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
    • 3. Absorption and Variable Costing Absorption Variable Costing Costing Direct materials Direct labor Product costsProduct costs Variable mfg. overhead Fixed mfg. overhead Period costsPeriod costs Selling & Admin. exp. The difference between absorption and variable costing is the treatment of fixed manufacturing overhead.
    • 4. Learning Objective 2McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
    • 5. Absorption and Variable Costing Mellon Co. produces a single product with the following information available: Number of units produced annually 25,000 Variable costs per unit: Direct materials, direct labor and variable mfg. overhead $ 10 Selling & administrative expenses $ 3 Fixed costs per year: Mfg. overhead $ 150,000 Selling & administrative expenses $ 100,000
    • 6. Absorption and Variable CostingUnit product cost is determined as follows: Absorption Variable Costing CostingDirect materials, direct labor, andvariable mfg. overhead $ 10 $ 10Fixed mfg. overhead ($150,000 ÷ 25,000 units) 6 -Unit product cost $ 16 $ 10 Selling and administrative expenses are always treated as period expenses and deducted from revenue.
    • 7. Absorption Costing Income StatementsMellon Co. had no beginning inventory, produced25,000 units and sold 20,000 units this year at $30 each. Absorption Costing Sales (20,000 × $30) $ 600,000 Less cost of goods sold: Beginning inventory $ - Add COGM (25,000 × $16) 400,000 Goods available for sale $ 400,000 Ending inventory (5,000 × $16) 80,000 320,000 Gross margin $ 280,000 Less selling & admin. exp. Variable (20,000 × $3) $ 60,000 Fixed 100,000 160,000 Net income $ 120,000
    • 8. Learning Objective 3McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
    • 9. Variable Costing Income StatementsNow let’s look at variable costing by Mellon Co. Variable CostingSales (20,000 × $30) $ 600,000Less variable expenses: Beginning inventory $ - Add COGM (25,000 × $10) 250,000 Goods available for sale $ 250,000 Ending inventory (5,000 × $10) 50,000 Variable cost of goods sold $ 200,000 Variable selling & administrative expenses (20,000 × $3) 60,000 260,000Contribution margin $ 340,000Less fixed expenses: Manufacturing overhead $ 150,000 Selling & administrative expenses 100,000 250,000Net income $ 90,000
    • 10. Comparing Absorption and Variable Costing Let’s compare the methods. Cost of Goods Ending Period Sold Inventory Expense TotalAbsorption costing Variable mfg. costs $ 200,000 $ 50,000 $ - $ 250,000 Fixed mfg. costs 120,000 30,000 - 150,000 $ 320,000 $ 80,000 $ - $ 400,000Variable costing Variable mfg. costs $ 200,000 $ 50,000 $ - $ 250,000 Fixed mfg. costs - - 150,000 150,000 $ 200,000 $ 50,000 $ 150,000 $ 400,000
    • 11. Learning Objective 4McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
    • 12. Reconciling Income UnderAbsorption and Variable Costing We can reconcile the difference between absorption and variable net income as follows: Variable costing net income $ 90,000 Add: Fixed mfg. overhead costs deferred in inventory (5,000 units × $6 per unit) 30,000 Absorption costing net income $ 120,000Fixed mfg. overhead $150,000 = = $6.00 per unit Units produced 25,000
    • 13. Learning Objective 5McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
    • 14. Cost-Volume-Profit Analysis• CVP includes all fixed costs to compute breakeven. – Variable costing and CVP are consistent as both treat fixed costs as a lump sum.• Absorption costing defers fixed costs into inventory. – Absorption costing is inconsistent with CVP because absorption costing treats fixed costs on a per unit basis.
    • 15. Learning Objective 6McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
    • 16. Evaluation of Variable Costing Management finds it Consistent with easy to understand. CVP analysis. Emphasizes contribution inAdvantages short-run pricing decisions. Impact of fixed Profit for period not costs on profits affected by changes emphasized. in fixed mfg. overhead.
    • 17. Evaluation of Absorption Costing Fixed manufacturing overhead is treated the same as the other product costs, direct material and direct labor. Consistent with long-run Advantages pricing decisions that must cover full cost. External reporting and income tax law require absorption costing. costing
    • 18. Impact of JIT Inventory Methods In a JIT inventory system . . . Production tends to equal sales . . . So, the difference between variable and absorption income tends to disappear.
    • 19. Learning Objective 7McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
    • 20. Throughput Costing Unit-level Product spending for cost direct costs.Unit-level costs are incurred every time a unit ofproduct is manufactured and will not be incurred again until the next unit is manufactured.
    • 21. Throughput Costing Example In an automated process direct material may be the only unit-level cost and so is the only product cost.All other manufacturing costs are expensed as period costs.Incentive to Average unit cost doesoverproduce not vary with changes is reduced in production levels. Advantages
    • 22. Learning Objective 8McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
    • 23. Throughput Income SatatementSales Revenue $600,000Throughput cost of goods sold (dir. mat.) 150,000Gross Margin $450,000Less: Operating costs Direct labor 100,000 Variable mfg overhead 60,000 Fixed mfg overhead 150,000 Variable sales & admin costs 50,000 Fixed sales & admin costs 125,000Total operating costs 375,000Net Income $ 75,000
    • 24. End of Chapter 17 The End