Variable Costing A. Alternative Income Statement Presentations 1.

Absorption Costing--under absorption costing all product costs are assigned to the units produced and are expensed when the units are sold a. Format--under absorption costing revenues are first reduced by all product cost to arrive at an intermediate figure called gross margin and then reduced by all period costs to arrive at a final net income figure Sales - Cost of Goods Sold: Direct Materials Direct Labor Variable Manufacturing Overhead Fixed Manufacturing Overhead = Gross Margin - Selling and Administrative Expenses: Variable Selling and Administrative Expenses Fixed Selling and Administrative Expenses = Net Income b. Application--absorption costing is a more effective tool for longrun decision making since it focuses attention on revenues and total production costs 2. Variable Costing--under variable costing variable product costs are assigned to the units produced and expensed when the units are sold and fixed product costs are treated as period costs and expensed when incurred a. Format--under variable costing revenues are first reduced by all variable costs to arrive at an intermediate figure called contribution margin and then reduced by all fixed costs to arrive at a final net income figure Sales - Variable Costs: Variable Cost of Goods Sold: Direct Materials Direct Labor Variable Manufacturing Overhead Variable Selling and Administrative Expenses = Contribution Margin - Fixed Costs: Fixed Manufacturing Overhead Fixed Selling and Administrative Expenses = Net Income b. Application--variable costing is a more effective tool for shortrun decision making since it focuses on revenues and variable costs

B.

Comparison of Absorption Costing Versus Variable Costing 1. Production > Sales--if the number of units produced is greater than the number of units sold, absorption costing will produce a higher net income since the fixed manufacturing overhead costs assigned to the increase in inventory will not be expensed during the current period a. Illustration--a corporation uses a standard costing system; standards are $1 per unit for direct materials, $7 per unit for direct labor, $2 per unit for variable manufacturing overhead, and $300,000 for fixed manufacturing overhead; normal capacity is 100,000 units; beginning inventory was 0 units; during the year 100,000 units were produced and 90,000 units were sold at $20 per unit; during the year actual manufacturing costs were equal to standard; during the year fixed selling and administrative expenses were $200,000 and variable selling and administrative expenses were $4 per unit Absorption Costing: Production Cost Per Unit = 1 + 7 + 2 + 300,000 / 100,000 = 13 Sales (90,000 x 20) Cost of Goods Sold at Standard (90,000 x 13) Gross Margin Selling and Administrative Expenses (200,000 + 90,000 x 4) Net Income Variable Costing: Production Cost Per Unit = 1 + 7 + 2 = 10 Sales (90,000 x 20) Variable Costs: Variable Cost of Goods Sold at Standard (90,000 x 10) Variable Selling and Administrative Expenses (90,000 x 4) Contribution Margin Fixed Costs: Fixed Manufacturing Overhead Fixed Selling and Administrative Expenses Net Income 1,800,000 900,000 _ 360,000 _ 1,260,000 _ _ 540,000 _ 500,000 _ 40,000 1,800,000 1,170,000 _ _ 630,000 560,000 _ _ _ 70,000

300,000 _ 200,000

Reconciliation of Net Income: Fixed Change Overhead In Per Inventory Unit (100,000 90,000) x 3 2.

= 30,000

Production < Sales--if the number of units produced is less than the number of units sold, absorption costing will produce a lower net income since the fixed manufacturing overhead costs assigned to the decrease in inventory will be expensed during the current period in addition to the fixed manufacturing overhead costs assigned to the unit produced during the current period a. Illustration--a corporation uses a standard costing system; standards are $1 per unit for direct materials, $7 per unit for direct labor, $2 per unit for variable manufacturing overhead, and $300,000 for fixed manufacturing overhead; normal capacity is 100,000 units; beginning inventory was 10,000 units; during the year 100,000 units were produced and 105,000 units were sold at $20 per unit; during the year actual manufacturing costs were equal to standard; during the year fixed selling and administrative expenses were $200,000 and variable selling and administrative expenses were $4 per unit Absorption Costing: Production Cost Per Unit = 1 + 7 + 2 + 300,000 / 100,000 = 13 Sales (105,000 x 20) Cost of Goods Sold at Standard (105,000 x 13) Gross Margin Selling and Administrative Expenses (200,000 + 105,000 x 4) Net Income Variable Costing: Production Cost Per Unit = 1 + 7 + 2 = 10 2,100,000 1,365,000 _ _ 735,000 620,000 _ _ _ 115,000

Sales (105,000 x 20) Variable Costs: Variable Cost of Goods Sold at Standard (105,000 x 10) Variable Selling and Administrative Expenses (105,000 x 4) Contribution Margin Fixed Costs: Fixed Manufacturing Overhead Fixed Selling and Administrative Expenses Net Income Reconciliation of Net Income: Fixed Change Overhead In Per Inventory Unit (100,000 105,000) x 3 = (15,000) 3.

2,100,000 1,050,000 _ 420,000 _ 1,470,000 _ _ 630,000 _ 500,000 _ 130,000

300,000 _ 200,000

Production Not Equal To Normal Capacity--if the number of units produced is not equal to normal capacity, under/overapplied fixed manufacturing overhead will result under absorption costing and will be treated as an adjustment to cost of goods sold if they are relatively small a. Illustration--a corporation uses a standard costing system; standards are $1 per unit for direct materials, $7 per unit for direct labor, $2 per unit for variable manufacturing overhead, and $300,000 for fixed manufacturing overhead; normal capacity is 100,000 units; beginning inventory was 5,000 units; during the year 98,000 units were produced and 95,000 units were sold at $20 per unit; during the year actual manufacturing costs were equal to standard; during the year fixed selling and administrative expenses were $200,000 and variable selling and administrative expenses were $4 per unit

Absorption Costing: Production Cost Per Unit = 1 + 7 + 2 + 300,000 / 100,000 = 13 Sales (95,000 x 20) Cost of Goods Sold: Cost of Goods Sold at Standard (95,000 x 13) Overhead Variance (300,000 98,000 x 3) Gross Margin Selling and Administrative Expenses (200,000 + 95,000 x 4) Net Income Variable Costing: Production Cost Per Unit = 1 + 7 + 2 = 10 Sales (95,000 x 20) Variable Costs: Variable Cost of Goods Sold at Standard (95,000 x 10) Variable Selling and Administrative Expenses (95,000 x 4) Contribution Margin Fixed Costs: Fixed Manufacturing Overhead Fixed Selling and Administrative Expenses Net Income Reconciliation of Net Income: Fixed Change Overhead In Per Inventory Unit (98,000 95,000) x 3 = 9,000 4. Actual Costs Not Equal To Standard Costs--if actual costs are not equal to standard costs, materials, labor, variable manufacturing overhead, and fixed manufacturing overhead variances will result; under absorption costing all variances will be treated as an adjustment to cost of goods sold if they are relatively small; under variable costing the materials, labor, and variable overhead variances will be treated as an adjustment to variable cost of goods sold if they are relatively small 1,900,000 950,000 380,000 _ _ 300,000 _ 200,000 1,330,000 _ _ 570,000 _ 500,000 _ 70,000 1,900,000 1,235,000 _ 6,000 _ 1,241,000 _ _ 659,000 580,000 _ _ _ 79,000

Illustration--a corporation uses a standard costing system and LIFO for inventory valuation purposes; standards are $1 per unit for direct materials, $7 per unit for direct labor, $2 per unit for variable manufacturing overhead, and $300,000 for fixed manufacturing overhead; normal capacity is 100,000 units; beginning inventory was 7,000 units; during the year 95,000 units were produced and 90,000 units were sold at $20 per unit; during the year actual direct materials costs were $19,000 higher than standard, actual direct labor costs were equal $9,500 lower than standard, actual variable manufacturing overhead was $194,750, and actual fixed manufacturing overhead was $313,500; during the year fixed selling and administrative expenses were $200,000 and variable selling and administrative expenses were $4 per unit Absorption Costing: Production Cost Per Unit = 1 + 7 + 2 + 300,000 / 100,000 = 13 Sales (90,000 x 20) Cost of Goods Sold: Cost of Goods Sold at Standard (90,000 x 13) Materials Variance Labor Variance Overhead Variance (194,750 + 313,500 95,000 x 5) Gross Margin Selling and Administrative Expenses (200,000 + 90,000 x 4) Net Income 1,800,000 1,170,000 ( _ 19,000 9,500) 33,250 1,212,750 _ _ _ 587,250 560,000 _ _ _ 27,250

a.

Variable Costing: Production Cost Per Unit = 1 + 7 + 2 = 10 Sales (90,000 x 20) Variable Costs: Variable Cost of Goods Sold: Variable Cost of Goods Sold at Standard 900,000 (90,000 x 10) Materials Variance 19,000 Labor Variance ( 9,500) Variable Overhead Variance 4,750 914,250 (194,750 95,000 x 2) _ _ Variable Selling and Administrative Expenses 360,000 (95,000 x 4) _ _ Contribution Margin Fixed Costs: Fixed Manufacturing Overhead 313,500 Fixed Selling and Administrative Expenses _ 200,000 Net Income Reconciliation of Net Income: Fixed Change Overhead In Per Inventory Unit (95,000 90,000) x 3 = 15,000 5. Variance Proration--if actual costs are not equal to standard costs and the resulting variances are relatively large, the variances are prorated to the units produced during the current period a. Illustration--a corporation uses a standard costing system and LIFO for inventory valuation purposes; standards are $1 per unit for direct materials, $7 per unit for direct labor, $2 per unit for variable manufacturing overhead, and $300,000 for fixed manufacturing overhead; normal capacity is 100,000 units; beginning inventory was 7,000 units; during the year 95,000 units were produced and 90,000 units were sold at $20 per unit; during the year actual direct materials costs were $19,000 higher than standard, actual direct labor costs were equal $9,500 lower than standard, actual variable manufacturing overhead was $194,750, and actual fixed manufacturing overhead was $313,500; during the year fixed selling and administrative expenses were $200,000 and variable selling and administrative expenses were $4 per unit 1,800,000

1,274,250 _ _ 525,750 _ 513,500 _ 12,250

Absorption Costing: Production Cost Per Unit = 1 + 7 + 2 + 300,000 / 100,000 = 13 Sales (90,000 x 20) Cost of Goods Sold: Cost of Goods Sold at Standard (90,000 x 13) Materials Variance (90,000 / 95,000 x 19,000) Labor Variance (90,000 / 95,000 x 9,500) Overhead Variance (90,000 / 95,000 x (194,750 + 313,500 95,000 x 5)) Gross Margin Selling and Administrative Expenses (200,000 + 90,000 x 4) Net Income 1,800,000 1,170,000 18,000 ( 9,000) 31,500 _ _ 1,210,500 _ _ 589,500 560,000 _ _ _ 29,500

Actual Production Cost Per Unit: Direct Materials = 1 + 19,000 / 95,000 Direct Labor = 7 9,500 / 95,000 Variable Manufacturing Overhead = 194,750 / 95,000 Fixed Manufacturing Overhead = 313,500 / 95,000

= 1.20 = 6.90 = 2.05 = _3.30 13.45

Variable Costing: Production Cost Per Unit = 1 + 7 + 2 = 10 Sales (90,000 x 20) Variable Costs: Variable Cost of Goods Sold: Variable Cost of Goods Sold at Standard 900,000 (90,000 x 10) Materials Variance 18,000 (90,000 / 95,000 x 19,000) Labor Variance ( 9,000) (90,000 / 95,000 x 9,500) Variable Overhead Variance 4,500 913,500 (90,000 / 95,000 x (194,750 95,000 x 2)) _ _ Variable Selling and Administrative Expenses 360,000 (95,000 x 4) _ _ Contribution Margin Fixed Costs: Fixed Manufacturing Overhead 313,500 Fixed Selling and Administrative Expenses _ 200,000 Net Income Actual Production Cost Per Unit: Direct Materials = 1 + 19,000 / 95,000 = 1.20 Direct Labor = 7 9,500 / 95,000 = 6.90 Variable Manufacturing Overhead = 194,750 / 95,000 = _2.05 10.15 Reconciliation of Net Income: Fixed Change Overhead In Per Inventory Unit (95,000 90,000) x 3.30 = 15,000 C. Costing Systems 1. Normal Costing--under normal costing actual direct materials and direct labor costs are assigned to the units produced and manufacturing overhead costs are assigned to the units produced using the predetermined overhead rate and the actual basis for allocation a. Small Variances--if the under/overapplied manufacturing overhead is relatively small, it is treated as an adjustment to cost of goods sold b. Large Variances--if the under/overapplied manufacturing overhead is 1,800,000

1,273,500 _ _ 526,500 _ 513,500 _ 13,000

2.

3.

relatively large, it is prorated to the units produced Standard Costing--under standard costing standard direct materials and direct labor costs are assigned to the units produced and manufacturing overhead costs are assigned to the units produced using the predetermined overhead rate and the standard basis for allocation a. Small Variances--if the direct materials, direct labor, and manufacturing overhead variances are relatively small, they are treated as an adjustment to cost of goods sold b. Large Variances-- if the direct materials, direct labor, and manufacturing overhead variances are relatively large, they are prorated to the units produced Actual Costing--under actual costing, actual direct materials, direct labor, and manufacturing overhead costs are assigned to the units produced

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