Variable%20Costing:%20A%20Tool%20for%20Management

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Variable Costing A Tool for Management
Chapter 7
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Overview of Absorption and Variable Costing
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Overview of Absorption and Variable Costing
No! You must consider these costs too!
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Overview of Absorption and Variable Costing
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Overview of Absorption and Variable Costing
Whos right? How should we treat the carpayment
and the insurance?
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Overview of Absorption and Variable Costing
VariableCosting
AbsorptionCosting
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Note Manufacturing Cost Flows

Balance Sheet Costs
Inventories
Income StatementExpenses
Material Purchases
Direct Labor
VariableManufacturing Overhead
FixedManufacturing Overhead
Selling andAdministrative
Period Costs
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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. . .

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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. . .

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Quick Check ?

• Which method will produce the highest retained
  earnings? (Hint Remember the balance sheet
  equation.)
• a. Absorption costing
• b. Variable costing
• c. There would be no difference in retained
  earnings under the two methods.
• d. It depends ...

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Quick Check ?

• Which method will produce the highest retained
  earnings? (Hint Remember the balance sheet
  equation.)
• a. Absorption costing
• b. Variable costing
• c. There would be no difference in retained
  earnings under the two methods.
• d. It depends ...

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Note Manufacturing Cost Flows

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Quick Check ?

• Which method will produce the highest
  cumulative net operating income?
• a. Absorption costing
• b. Variable costing
• c. There would be no difference in cumulative
  net operating income under the two methods.
• d. It depends ...

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Quick Check ?

• Which method will produce the highest
  cumulative net operating income?
• a. Absorption costing
• b. Variable costing
• c. There would be no difference in cumulative
  net operating income under the two methods.
• d. It depends ...

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Quick Check ?

• If the Internal Revenue Service lets you use
  either absorption or variable costing, which
  method should you choose to minimize your taxes?
  (Assume that once you have decided which method
  to use, you cannot later change.)
• a. Absorption costing.
• b. Variable costing.
• c. The two methods would have the same effect
  on taxes.

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Quick Check ?

• If the Internal Revenue Service lets you use
  either absorption or variable costing, which
  method should you choose to minimize your taxes?
  (Assume that once you have decided which method
  to use, you cannot later change.)
• a. Absorption costing.
• b. Variable costing.
• c. The two methods would have the same effect
  on taxes.

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Overview of Absorption and Variable Costing
Lets put some numbers to theissue and see if it
willsharpen our understanding.
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Unit Cost Computations

• Harvey Co. produces a single product with the
  following information available

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Unit Cost Computations

• Unit product cost is determined as follows

Selling and administrative expenses arealways
treated as period expenses and deducted from
revenue.
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Income Comparison of Absorption and Variable
Costing

• Harvey Co. had no beginning inventory, produced
  25,000 units and sold 20,000 units this year.

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Income Comparison of Absorption and Variable
Costing

• Harvey Co. had no beginning inventory, produced
  25,000 units and sold 20,000 units this year.

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Income Comparison of Absorption and Variable
Costing

• Now lets look at variable costing by Harvey Co.

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Quick Check ?

• The net operating income under absorption
  costing was 120,000 and under variable costing
  it was 90,000 because of higher expenses. Where
  is the missing 30,000 under absorption costing?
• a. It has disappeared into an accounting black
  hole.
• b. It is in ending inventories.
• c. It represents taxes that have been saved.
• d. The 30,000 wasnt a real cost, so nothing
  is really missing.

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Quick Check ?

• The net operating income under absorption
  costing was 120,000 and under variable costing
  it was 90,000 because of higher expenses. Where
  is the missing 30,000 under absorption costing?
• a. It has disappeared into an accounting black
  hole.
• b. It is in ending inventories.
• c. It represents taxes that have been saved.
• d. The 30,000 wasnt a real cost, so nothing
  is really missing.

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Income Comparison of Absorption and Variable
Costing

• Lets compare the methods.

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Reconciliation
We can reconcile the difference
betweenabsorption and variable income as follows
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Extending the Example
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Harvey Co. Year 2

• In its second year of operations, Harvey Co.
  started with an inventory of 5,000 units,
  produced 25,000 units and sold 30,000 units.

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Harvey Co. Year 2

• Unit product cost is determined as follows

No change in Harveys cost structure.
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Harvey Co. Year 2
Now lets look at Harveys income
statement assuming absorption costing is used.
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Harvey Co. Year 2
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Harvey Co. Year 2
Next, well look at Harveys income
statement assuming
is used.
Variable costing
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Harvey Co. Year 2
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Reconciliation
We can reconcile the difference
betweenabsorption and variable income as follows
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Summary
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Summary
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Advantages of the Contribution Approach
Advantages
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Variable versusAbsorption Costing
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Variable versusAbsorption Costing
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Variable versusAbsorption Costing
Absorption costing product costs are misleading
for decision making.
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Note on theEffects of Volume
Absorption CostingCost of goods sold decreases
because production exceeds sales, leaving a
portion of fixedmanufacturing costs in inventory.
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Note on theEffects of Volume
Absorption CostingCost of goods sold decreases
because production exceeds sales, leaving a
portion of fixedmanufacturing costs in inventory.
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Impact of JIT Inventory Methods
In a JIT inventory system . . .
Productiontends to equalsales . . .
So, the difference between variable
and absorption income tends to disappear.
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End of Chapter 7