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Cost Accounting Horngreen, Datar, Foster
Inventory-Costing Methods
The difference between variable costing and absorption costing is based on the treatment of fixed manufacturing overhead.
DirectMaterials
VariableFactoryLabor
(variable)Overhead
Work in Process Inventory
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Cost Accounting Horngreen, Datar, Foster
Variable Costing
Work in ProcessInventory
Finished GoodsInventory
Cost of Goods Sold
Income Summary
Fixed ManufacturingOverhead
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Cost Accounting Horngreen, Datar, Foster
Absorption Costing
Work in ProcessInventory incl fixed
costs
Finished GoodsInventory
Cost of Goods Sold
Income Summary
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Cost Accounting Horngreen, Datar, Foster
Comparing Income Statements
The following data pertain to Davenport Fixtures:
Year 1 Year 2 TotalBeginning inventory -0- 2,000 -0-Produced 10,000 11,500 21,500Sold 8,000 13,000 21,000Ending inventory 2,000 500 500
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Cost Accounting Horngreen, Datar, Foster
Comparing Income Statements
The following information is on a per unit basis:
Sales price: $71.00Variable manufacturing costs:
Direct materials: $ 4.00Direct manufacturing labor: $21.00Indirect manufacturing costs: $24.00
Fixed manufacturing costs: $ 4.50
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Cost Accounting Horngreen, Datar, Foster
Comparing Income Statements(Absorption Costing)
Total fixed production costs are $54,000 at a normal capacity of 12,000 units.Fixed nonmanufacturing costs are $30,000 per year.Variable nonmanufacturing costs are $2.00 per unit sold.
Revenues $568,000Cost of goods sold 428,000Volume variance (U) 9,000Gross margin $131,000Nonmanufacturing costs 46,000Operating income $ 85,000
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Cost Accounting Horngreen, Datar, Foster
Comparing Income Statements(Absorption Costing)
Revenues for Year 1 are $568,000.What is the cost of goods sold?• 8,000 × $53,5 = $428,000
What is the Gross margin?• $568,000 – $428,000 –$9.000 = $131,000• Operating Income = $131,000 - $46,000 = $85,000
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Cost Accounting Horngreen, Datar, Foster
Comparing Income Statements (Variable Costing)
Revenues $568,000Cost of goods sold 392,000Variable nonmanufacturing costs 16,000Contribution margin $160,000Fixed manufacturing costs 54,000Fixed nonmanufacturing costs 30,000Operating income $ 76,000
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Cost Accounting Horngreen, Datar, Foster
Operating Income (Absorption Costing)
What are revenues for Year 2?• 13,000 × $71 = $923,000
What is the cost of goods sold?• 13,000 × $53.50 = $695,500
Is there a volume variance?• (12,000 – 11,500) × $4.50 = $2,250
underallocated fixed manufacturing costsWhat is the gross margin?• $923,000 – ($695,500 + $2,250) = $225,250
What are the nonmanufacturing costs?• 13,000 units sold × $2.00 = $26,000
variable costs + $30,000 fixed costs = $56,000
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Cost Accounting Horngreen, Datar, Foster
Operating Income (Absorption Costing)
What is the operating income before taxes?• $225,250 – $56,000 = $169,250
What is the operating income for the two years combined?• $85,000 + $169,250 = $254,250
Year 1 Year 2 CombinedRevenues $568,000 $923,000 $1,491,000Cost of goods sold 428,000 695,500 1,123,500Volume variance (U) 9,000 2,250 11,250Gross margin $131,000 $225,250 $ 356,250Nonmfg. costs 46,000 56,000 102,000Operating income $ 85,000 $169,250 $ 254,250
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Cost Accounting Horngreen, Datar, Foster
Operating Income (Variable Costing)
Revenues for Year 2 are $923,000.What is the cost of goods sold?• 13,000 × $49 = $637,000
What is the manufacturing contribution margin?• $923,000 – $637,000 = $286,000
What is the net contribution margin?• $286,000 – $26,000 variable nonmanufacturing costs = $260,000 net
contribution margin
What is the operating income before taxes?• $260,000 – $54,000 fixed manufacturing costs – $30,000 fixed
nonmanufacturing costs = $176,000
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Cost Accounting Horngreen, Datar, Foster
Income Statements (Variable Costing)
Year 1 Year 2 CombinedRevenues $ 568,000 $923,000 $1,491,000Cost of goods sold 392,000 637,000 1,029,000Mfg. contr. margin $176,000 $286,000 $ 462,000Variable nonmfg. 16,000 26,000 42,000Net contr. margin $160,000 $260,000 $ 420,000Fixed mfg. costs 54,000 54,000 108,000Fixed nonmfg. costs 30,000 30,000 60,000Operating income $ 76,000 $176,000 $252,000
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Cost Accounting Horngreen, Datar, Foster
Comparison of Variableand Absorption Costing
Variable costing operating income Year 1: $76,000Absorption costing operating income Year 1: $85,000Absorption costing operating income is $9,000 higher.
Variable costing operating income Year 2: $176,000Absorption costing operating income Year 2: $169,250Variable costing operating income is $6,750 higher.
Why?
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Cost Accounting Horngreen, Datar, Foster
Comparison of Variable and Absorption Costing
Production exceeds sales in Year 1The 2,000 units in ending inventory are valued as follows:Absorption costing: 2,000 × $53.50 = $107,000Variable costing: 2,000 × $49.00 = $ 98,000Difference: $ 9,000
Sales exceeded units produced in Year 2.13,000 – 11,500 = 1,500 decrease in inventoryAbsorption costing: 1,500 × $53.50 = $80,250Variable costing: 1,500 × $49.00 = $73,500Higher cost of goods sold under absorption costing: $ 6,750
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Cost Accounting Horngreen, Datar, Foster
Comparison of Variable and Absorption Costing
Variable costing combined net income: $252,000Absorption costing combined net income: $254,250Absorption costing is higher by $2,250 500 units in inventory × $4.50 = $2,250
Absorption costingoperating income
Variable costingoperating income
Fixed manufacturingcosts in endinginventory under
absorption costing
Fixed manufacturingcosts in beginning
inventory underabsorption costing
–
EQUALS
–
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Cost Accounting Horngreen, Datar, Foster
Undesirable effects of producing for inventory with absorption costing
Production of items that absorb minimal fixed manufacturing costs may be delayed.A plant manager may accept a particular order to increase production even though another plant in the same company is better suited to handle that order.A plant manager may defer maintenance.
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Cost Accounting Horngreen, Datar, Foster
Revising Performance Evaluation under Absorption Costing
Budget carefully and use inventory planning.Discontinue the use of absorption costing for internal reporting and instead use variable costing.Incorporate a carrying charge for inventory.Lengthen the time period used to evaluate performance.Include nonfinancial as well as financial variables in the measures used to evaluate performance.• Ending inventory in units this period ÷ Ending inventory in units last
period• Sales in units this period ÷ Ending inventory in units this period
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Cost Accounting Horngreen, Datar, Foster
Inventory Buildup with Absorption Costing
Assume that Davenport Fixtures produced 4,400 units in Year 1 and sold 4,100.What is the production volume variance? • (12,000 – 4,400) × $4.50 = $34,200 U
What is the net operating income or loss for the period?
Revenues (4,100 × $71) $291,100Cost of goods sold (4,100 × $53.50) 219,350Volume variance 34,200Gross margin $ 37,550Nonmanufacturing costs 38,200Net loss $ 650
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Cost Accounting Horngreen, Datar, Foster
Inventory Buildup
How many units are in ending inventory?• 4,400 – 4,100 = 300
How much cost is in ending inventory?• 300 × $53.50 = $16,050
Suppose that management decides to produce 9,000 units next year.Sales remain the same (4,100 units). What is the volume variance?(12,000 – 9,000) × $4.50 = $13,500 UWhat is the operating income or loss?
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Cost Accounting Horngreen, Datar, Foster
Inventory Buildup
How many units are in ending inventory?• 300 + 9,000 – 4,100 = 5,200
How much cost is in ending inventory?• 5,200 × $53.50 = $278,200
Revenues (4,100 × $71) $291,100Cost of goods sold (4,100 × $53.50) 219,350Volume variance 13,500Gross margin $ 58,250Nonmanufacturing costs 38,200Net income $ 20,050
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Cost Accounting Horngreen, Datar, Foster
Throughput Costing
Revenues $568,000Variable direct materialscost of goods sold 32,000
Throughput contribution margin $536,000Manufacturing costs 504,000Nonmanufacturing costs 46,000Operating loss $ 14,000
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Cost Accounting Horngreen, Datar, Foster
Throughput Costing
Manufacturing Costs:Labor $21.00 × 10,000 $210,000Indirect costs $24.00 × 10,000 240,000Fixed costs 54,000Total manufacturing costs $504,000
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Cost Accounting Horngreen, Datar, Foster
Throughput Costing
What are other nonmanufacturing costs for the year? Nonmanufacturing Costs:• Variable $2.00 × 8,000 $16,000• Fixed 30,000• Total $46,000
Variable costing operating income: $76,000Throughput costing operating loss: $14,000Difference in operating income: $90,000How can this difference be explained?
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Cost Accounting Horngreen, Datar, Foster
Throughput Costing
The 2,000 units in ending inventoryare valued as follows:
Variable2,000 × $49 = $98,000
Throughput2,000 × $4 = $8,000
$90,000 difference
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Cost Accounting Horngreen, Datar, Foster
Throughput Costing
Absorption costing operating income: $85,000Throughput costing operating loss: $14,000Difference in operating income: $99,000How can this difference be explained?
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Cost Accounting Horngreen, Datar, Foster
Throughput Costing
The 2,000 units in ending inventoryare valued as follows:
Absorption2,000 × $53.50 =
$107,000
Throughput2,000 × $4= $8,000
$99,000 difference
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Cost Accounting Horngreen, Datar, Foster
Comparison of Inventory Costing Methods
Actual Costing
AbsorptionCosting
ThroughputCosting
VariableCosting
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Cost Accounting Horngreen, Datar, Foster
Comparison of Inventory Costing Methods
Normal Costing
AbsorptionCosting
ThroughputCosting
VariableCosting
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Cost Accounting Horngreen, Datar, Foster
Comparison of Inventory Costing Methods
Standard Costing
AbsorptionCosting
ThroughputCosting
VariableCosting
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Cost Accounting Horngreen, Datar, Foster
Alternative Denominator-Level Concepts
The choice of the denominator used to allocate budgeted fixed manufacturing costs to products can greatly affect the numbers a normal or standard (absorption) costing system will report prior to the end of an accounting period.
Theoretical capacityPractical capacityNormal capacityMaster-budget capacity
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Cost Accounting Horngreen, Datar, Foster
Theoretical Capacity
Theoretical capacity xt
(maximum or ideal capacity) is the denominator level concept that is based on producing at full (peak) efficiency all the time.
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Cost Accounting Horngreen, Datar, Foster
Practical Capacity
Practical capacity xp
is the denominator-level concept that reduces theoretical capacity by unavoidable operating interruptions.The use of practical capacity is required by the Internal Revenue Service (IRS).
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Cost Accounting Horngreen, Datar, Foster
Normal Capacity
Normal capacity xn
is the denominator-level concept based on the level of capacity utilization that satisfies average customer demand over several periods.It includes seasonal, cyclical, and trend factors.
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Cost Accounting Horngreen, Datar, Foster
Master-Budget Capacity
Master-budget capacity xm
is the denominator-level concept based on the expected level of capacity utilization for the next budget period (typically one year).
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Cost Accounting Horngreen, Datar, Foster
Choosing a Capacity Level
What factors are consideredin choosing a capacity level?
Productcosting
Pricingdecision
Performanceevaluation
Financialstatements
Regulatoryrequirements Difficulty
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Cost Accounting Horngreen, Datar, Foster
Downward Demand Spiral
The use of normal capacity utilization or master-budget capacity utilization can result in capacity costs being spread over a small number of output units.The downward demand spiral is the continuing reduction in demand that occurs when the prices of competitors are not met and demand drops.
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Cost Accounting Horngreen, Datar, Foster
True or False??
When variable costing is used, the firm will be looking for the gross margin. The income under variable costing will never be the same as the income under absorption costing.Under variable costing, only the quantity of units sold drives operating income, the production level has no impact at all. Theoretical capacity is the capacity level that represents what the firm is able to obtain under reasonable circumstances. In the short run, capacity costs are usually fixed.
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Cost Accounting Horngreen, Datar, Foster
Pick your Choice I:
TTF, Inc., which just began business this year, has the following information about JJI, the only product that it produces and sells. JJI sells for $25 per unit. During the current year, 20,000 units of JJI were sold. During the period, TTF manufactured 22,000 units of JJI. The following costs were available: variable costs per unit: direct materials -$ 8; direct labor - $4; variable manufacturing overhead - $2; variable selling - $3. The indirect fixed costs for TTF were manufacturing costs $55,000 and marketing $33,000. What is the unit cost to be recorded in inventory under absorption costing?$14.00 $16.50 $17.00 $19.50
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Cost Accounting Horngreen, Datar, Foster
Pick your Choice II:
POR has the following information with regard to capacity. Theoretical capacity is 100,000 units, practical capacity is 80,000 units, normal capacity is 75,000 units, and the current period master-budget capacity is 70,000 units. During the current period the actual level achieved was 72,000 units. If the fixed manufacturing costs for the period were budgeted at $300,000 and the firm uses normal capacity as its activity level, what would the production-volume variance be for the current period?$0 $12,000 Unfavorable $12,000 Favorable $15,000 Unfavorable
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