Variable Costing for Management Analysis

1
Variable Costing for Management Analysis

• ACG 2071
• Module 8
• Chapter 20
• Fall 2007

2
Costing

• One of the most important items affecting a
  business net income is the cost of goods sold.
• Net income can be determined by
• Absorption costing
• Variable costing or Direct costing

3
Absorption Costing

• all manufacturing costs included in finished
  goods and remain an asset until the good is sold.
• Used in financial reporting

4
Variable Costing

• cost of goods manufactured is composed only of
  variable manufacturing costs
• direct materials
• direct labor
• variable factory overhead
• remaining manufacturing costs (fixed) are
  generally related to productive capacity of
  manufacturing plant and not affected by changes
  in the quantity of product manufacturing
• thus treated as an expense
• also called direct costing

5
Variable costing

• More useful to management in making decisions
• Also called direct costing
• The cost of goods manufactured is composed only
  of variable manufacturing costs
• Fixed costs are below the line

6
Cost of Goods Manufactured
7
Example 1 Joes Hose
Sales are 15,000 at 50 per unit
8
Variable Costing Income Statement

• Manufacturing margin
• Sales minus variable cost of goods sold
• Contribution margin
• Manufacturing margin minus variable selling and
  administrative expenses

9
Variable Costing Income Statement
10
Absorption Costing Income Statement
Note In the above example the variable costing
and absorption costing income statement results
in the same income. This is due to the fact that
no beginning or ending inventory exists
11
Ending Inventory Exists

• When ending inventory exists, the operating
  income for variable costing will be LOWER than
  that for absorption costing. This is due to the
  fact that the fixed costs assigned to the ending
  inventory is expensed under variable costing and
  inventoried under absorption costing.

12
Ending Inventory Exists

• Units manufactured gt Units Sold
• Example 2 Joe Hose manufactures 15,000 units and
  sold 12,000 units at 50 per unit. Using the
  information on costs from Example 1, prepare a
  variable costing income statement and absorption
  costing income statement.

13
Absorption costing
Selling and administrative Variable 5 x
12,000 units 60,000 Fixed
50,000 Total
110,000
14
Variable costing
15
Difference
Variable costing operating income 40,000 Absorpt
ion costing operating income 70,000 Difference
30,000 The difference is account for by
the following Ending inventory 3,000
units Fixed costs per unit x 10 Difference
in operating income 30,000
16
Beginning inventory exists

• Units manufactured lt Units Sold
• When beginning inventory exists, the operating
  income for variable costing will be HIGHER than
  that for absorption costing. This is due to the
  fact that the fixed costs assigned to the ending
  inventory is expensed under variable costing and
  inventoried under absorption costing

17
Absorption Costing

• Sales (15,000_at_50) 750,000.00
• Cost of goods sold
• Beg Inv (5,000 units _at_ 35) 175,000
• COGM (12,000 _at_35) 400,000
  575,000
• Gross profit
  175,000
• Selling and Administrative
• (5 15,000) 50,000 125000
• Income from operations 70,000
  125,000
• Operating income 50,000

18
Example 3

• Example 3 Joe Hose had beginning inventory of
  5,000 units, 10,000 units were manufactured
  during the year. The company sold 15,000 units
  at 50 per unit during the period. Below are the
  costs of operations for the period.

19
Example 3 Data
20
Variable Costing
21
Absorption Costing
Selling and administrative Variable
selling 5per unit x 15,000
units sold 75,000 Fixed
selling
50,000 Total 110,000
22
Difference

• If manufactured units are less than sales then
  difference in income of 50,000 comes from
  difference in Cost of goods sold of 10 per unit
  times 5,000 units.
• Variable costing operating income 100,000
• Absorption costing operating income 50,000
• Difference 50,000
• The difference is account for by the following
• Beginning inventory 5,000 units
• Fixed costs per unit x 10
• Difference in operating income 50,000
• 10 per unit is the fixed costs per unit
  charged to beginning inventory.

23
Income Analysis

• Since absorption costing, inventories fixed cost
  for the period, the company may show higher
  income if it produces more than it sells.
• For example look at two production levels.

24
Under Variable Costing
25
Controlling costs

• All costs are controllable in long run by someone
  in the business but not all controllable at the
  same level of management.
• Controllable influenced by management at that
  level
• Noncontrollable another level of management
  control
• Used to fix responsibility
• Variable manufacturing costs controlled by
  operating level
• Fixed manufacturing costs higher level controls
  it

26
Pricing Products

• Variable costs used in setting prices because it
  gives better control over costs

27
Analyzing market segments

• Market analysis is performed by sales and
  marketing department in order to determine the
  profit contributed by market segments.
• Market segment is a portion of the business that
  can be assigned to a manager for profit
  responsibility.

28
Analyzing market segments


29
Sales Territory Profit Analysis
30
Product Profitability Analysis

• Management should focus its sales efforts on
  those products that will provide the maximum
  total contribution margin.
• An income statement presenting the contribution
  margin by products is often used by management to
  guide product-related sales and promotional
  efforts

31
Product Profitability Analysis
32
Contribution Margin Analysis

• The contribution margin concept can be used to
  assist managers in planning and controlling
  operations by focusing on the differences between
  planned and actual contribution margins.
• These differences and their causes are explained
  by the contribution margin analysis
• Contribution margin Sales Variable Costs

33
Contribution Margin Analysis

• Difference in planned and actual contribution
  margin can be caused by
• An increase or decrease in the amount of sales
• Caused by
• Increase or decrease in units sold
• Increase or decrease in selling price
• An increase or decrease in the amount of variable
  costs
• Caused by
• Increase or decrease in units sold
• Increase or decrease in costs per unit

34
Contribution Margin Analysis

• Explained by
• Quantity factor
• The effect of a difference in the number of units
  sold assuming no change in unit sales price or
  unit cost
• Actual quantity sold planned quantity sold
• Price factor
• The effect of a difference in unit sales price or
  unit cost on the number of units sold.
• Actual unit price or cost planned unit price or
  cost

35
Contribution Margin Analysis
36
Contribution Margin Analysis

• The analysis of this data shows a favorable
  increase of 25,000 in the contribution margin
  was due in large pat to an increase in the number
  of units sold. The increase was partially
  offset by a decrease in sales price and increase
  in unit cost for variable selling and
  administrative expenses. An additional decrease
  in unit cost for variable cost of goods sold
  occurred.

37
Contribution Margin Analysis
38
Contribution Margin Analysis
39
Contribution Margin Analysis