Variable Costing for Management Analysis

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Variable Costing for Management Analysis
Student Version
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Describe and illustrate reporting income from
operations under absorption and variable costing.
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Absorption Costing
Absorption costing is required under generally
accepted accounting principles for financial
statements distributed to external users.
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Variable Costing
For internal use in decision making, managers
often use variable costing.
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Assume that 15,000 units are manufactured and
sold at a price 50.
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Exhibit 1
Absorption Costing Income Statement
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Contribution Margin
Note in Exhibit 2 that the variable selling and
administrative expenses are deducted from the
manufacturing margin to yield the contribution
margin.
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Exhibit 2
Variable Costing Income Statement
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Income from Operations When Units Manufactured
Exceed Units Sold
Assume that in the preceding example only 12,000
units of the 15,000 units manufactured were sold.
Examine Exhibit 3 and you will see that income
from operations using variable costing is 40,000
while absorption costing provides an income of
70,000.
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Units Manufactured Exceed Units Sold
Exhibit 5
Exhibit 3
(continued)
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Exhibit 5
Units Manufactured Exceed Units Sold
Exhibit 3
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Income from Operations When Units Manufactured
Are Less than Units Sold
Assume that 5,000 units of inventory were on hand
at the beginning of a period, 10,000 units were
manufactured during the period, and 15,000 units
were sold at 50 per unit.
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Exhibit 5
Units Manufactured Are Less Than Units Sold
Exhibit 4
(continued)
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Exhibit 5
Units Manufactured Are Less Than Units Sold
Exhibit 4
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2
Describe and illustrate the effects of absorption
and variable costing on analyzing income from
operations.
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Frand Manufacturing Company
Frand Manufacturing Company has no beginning
inventory and sales are estimated to be 20,000
units at 75 per unit, regardless of production
levels.
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Proposal 1 20,000 Units to be Manufactured and
Sold
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Proposal 2 25,000 Units to be Manufactured and
20,000 Units to be Sold
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Exhibit 5
Absorption Costing Income Statements for Two
Production Levels
Exhibit 5
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Frand Manufacturing Company
Now, assume that Frand Manufacturing uses
variable costing and has sales of 20,000 units.
Exhibit 6 illustrates that net income remains a
constant 200,000 at the three levels of
production.
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Variable Income Statements for Three Production
Levels
Exhibit 6
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3
Describe managements use of absorption and
variable costing.
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Pricing Products
Many factors enter into determining the selling
price of a product. However, the cost of making
the product is significant in all pricing
decisions. In the short run, fixed costs cannot
be avoided.
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Pricing Products
In the long run, a company must set its selling
price high enough to cover all costs and expenses
(variable and fixed) and generate income.
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Analyzing Market Segments
A market segment is a portion of a business that
can be analyzed using sales, costs, and expenses
to determine its profitability.
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4
Use variable costing for analyzing market
segments, including product, territories, and
salespersons segments.
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Analyzing Market Segments
Camelot Fragrance Company manufactures and sells
the Gwenevere perfume for women and the Lancelot
cologne line for men. The inventories are
negligible.
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Sales Territory Profitability Analysis
Sales territory profitability analysis may lead
management to

1. Reduce costs in lower-profit sales territories

1. Increase sales efforts in higher-profit
   territories

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Sales Territory Profitability Analysis
To illustrate the analysis of profit differences
by sales territory, Exhibit 8 shows the variable
costing income statements by sales territories
for Camelot Fragrance Company.
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Contribution Margin by Sales Territory Report
Exhibit 8
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Sales Territory Profitability Analysis
Contribution Margin Ratio
Contribution Margin Sales

Northern territory 43 (34,400/80,000) Southern
territory 50.5 (40,400/80,000)
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Sales mix, sometimes referred to as product mix,
is defined as the relative distribution of sales
among the various products sold.
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Contribution Margin by Product Line Report
Exhibit 9
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Contribution Margin by Salesperson Report
Exhibit 10
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5
Use variable costing for analyzing and explaining
changes in contribution margin as a result of
quantity and price factors.
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Quantity factor is the effect of a difference in
the number of units sold, assuming no change in
unit sales price or unit cost.
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Unit price factor or unit cost factor is the
effect of a difference in unit sales price or
unit cost on the number of units sold.
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Contribution Margin Analysis
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Exhibit 12
Contribution Margin Analysis Report
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Describe and illustrate the use of variable
costing for service firms.
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Variable Costing Income Statement
Exhibit 14
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Blue Skies Airlines
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Contribution Margin by Segment ReportService Firm
Exhibit 15
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Contribution Margin Analysis ReportService
Company
Exhibit 16


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