Managerial Accounting

by James Jiambalvo
Chapter 5:
Variable Costing

Slides Prepared by:

Scott Peterson
Northern State
University
Objectives
1. Explain the difference between full
(absorption) and variable costing.
2. Prepare an income statement using
variable costing.
3. Discuss the effect of production on full
and variable costing income.
4. Explain the impact of JIT (just-in-time) on
the difference between full and variable
costing income.
5. Discuss the benefits of variable costing for
internal reporting purposes
Full (Absorption) Costing
1. Full (Absorption) Costing includes:
a. Direct material
b. Direct labor
c. Manufacturing overhead (both
variable and fixed)
2. Decision making and “what-if”
decisions are difficult because of the
commingling of fixed and variable
overhead.
3. Required for GAAP.
Variable Costing
1. Variable Costing includes:
a. Direct material
b. Direct labor
c. Variable Manufacturing overhead
2. Variable Costing lends itself well to
decision making and “what-if”
analyses.
3. Not allowed for GAAP.
Differences Between Full
(Absorption) and Variable
Costing
1. Fixed manufacturing overhead
(included in Full Costing).
2. Fixed manufacturing costs, like
depreciation, are a period
expense on the income statement
under variable costing.
3. Fixed manufacturing costs, like
depreciation, are inventoried until
sold under full costing.
Variable Costing Income
Statement
1. The format uses a contribution margin
approach.
2. All costs, manufacturing, selling and
administrative, are classified as either
fixed or variable.
Variable Costing Income
Statement Example
Sales $100,000
Less Variable:
Variable COGS $20,000
Variable Selling 10,000
Variable Admin. 5,000 35,000
Contribution Margin 65,000
Less Fixed:
Fixed Mfg. 10,000
Fixed Selling 8,000
Fixed Admin 7,000 25,000
Net Income 40,000
Full (Absorption) Costing
Income Statement Example
Sales $100,000
Less COGS 30,000
Gross Margin 70,000
Less Selling and Admin:
Selling 18,000
Admin 12,000 30,000
Net Income 40,000
Effects of Production on
Income for Full Versus Variable
Costing: Clausen Tube
Facts:
 5,000 units produced and sold
 Selling Price: $2,000 per unit
 Variable Manufacturing:
 Direct Materials: $600 per unit
 Direct Labor: $225 per unit
 Variable MFG: $75 per unit
 Fixed Manufacturing: $1,200,000 per year
 Selling Expense: $40 per unit variable plus
$100,000 fixed.
 Administrative: $500,000 per year (fixed)
Clausen Tube Income
Statement: Full Costing
Sales $10,000,000
Less COGS 5,700,000
Gross Margin 4,300,000
Less Selling and Admin:
Selling $300,000
Admin 500,000 800,000
Net Income $3,500,000
Clausen Tube Income
Statement: Variable Costing
Sales $10,000,000
Less Variable:
Variable COGS $4,500,000
Variable Selling
and Admin 200,000
Contribution Margin 5,300,000
Less Fixed:
Fixed Mfg. 1,200,000
Fixed Selling 100,000
Fixed Admin 500,000 1,800,000
Net Income $3,500,000
Variable Costing Income
Statement: Considerations
1. When sales volume and production
volume are exactly equal, net income
is the same under either full or variable
costing.
2. Contribution margin is easily calculated
under variable costing: 2,000 – 940 =
1,060.
3. Contribution margin ratio is: 1,060 /
2,000 = 53%
Clausen Tube: Production is
Greater Than Sales
Facts:
 6,000 units produced and 4,800 units sold
 Selling Price: $2,000 per unit
 Variable Manufacturing:
 Direct Materials: $600 per unit
 Direct Labor: $225 per unit
 Variable MFG: $75 per unit
 Fixed Manufacturing: $1,200,000 per year
 Selling Expense: $40 per unit variable plus
$100,000 fixed.
 Administrative: $500,000 per year (fixed)
Clausen Tube Income
Statement: Full Costing--
Production > Sales
Sales $ 9,600,000
Less COGS 5,280,000
Gross Margin 4,320,000
Less Selling and Admin:
Selling $292,200
Admin 500,000 792,200
Net Income $3,528,000
Clausen Tube Income
Statement: Variable Costing--
Production > Sales
Sales $ 9,600,000
Less Variable:
Variable COGS $4,320,000
Variable Selling
and Admin 192,000
Contribution Margin 5,088,000
Less Fixed:
Fixed Mfg. 1,200,000
Fixed Selling 100,000
Fixed Admin 500,000 1,800,000
Net Income $3,288,000
Variable Costing Income
Statement: Considerations--
Production > Sales
1. Net income is higher under full costing
than variable costing.
2. $3,528,000 vs. $3,288,000 = $240,000
3. The $240,000 difference is due to the
1,200 (6,000 – 4,800) additional units
produced and unsold.
4. Fixed manufacturing $1,200,000 /
6,000 units x 1,200 units remaining =
$240,000
Summary of Effects of
Production on Net Income
 If units produced = units sold, then no
difference between full costing and
variable costing net income.
 If units produced > units sold, then full
costing net income is greater than
variable costing net income.
 If units produced < units sold, then full
costing net income is less than variable
costing net income.
Impact of JIT on the Income
Effects of Full Versus Variable
Costing
1. JIT (Just-In-Time) inventory systems
lead to low inventories.
2. Results in little difference between
production and sales.
3. Variable versus absorption net income
differences negligible.
Benefits of Variable Costing for
Internal Reporting
1. Variable costing facilitates C-V-P
analysis because it uses a
“contribution” approach.
2. Variable costing mitigates the effects of
earnings management because fixed
manufacturing costs are not
inventoried. Thus, merely increasing
production volume relative to sales will
not boost net income.
Quick Review Question #1

1. Which of the following lends itself well

to C-V-P Analysis?
a. Full Costing
b. Absorption Costing
c. Variable Costing
d. Average Costing
Quick Review Answer #1

1. Which of the following lends itself well

to C-V-P Analysis?
a. Full Costing
b. Absorption Costing
c. Variable Costing
d. Average Costing
Quick Review Question #2
2. Units produced = 2,000, units sold =
1,800, contribution margin ratio is
37%, fixed S & A expenses are
$90,000. Fixed mfg. Expenses are
$80,200 By how much is net income
greater under full costing than variable
costing?
a. $8,020
b. $80,200
c. $9,000
d. $17,020
Quick Review Answer #2
2. Units produced = 2,000, units sold =
1,800, contribution margin ratio is
37%, fixed S & A expenses are
$90,000. Fixed mfg. Expenses are
$80,200 By how much is net income
greater under full costing than variable
costing?
a. $8,020
b. $80,200
c. $9,000
d. $17,020
Quick Review Question #3

3. Which of the following complies with

GAAP for external reporting purposes?
a. Absolute costing
b. Variable costing
c. Fixed costing
d. Absorption costing
Quick Review Answer #3

3. Which of the following complies with

GAAP for external reporting purposes?
a. Absolute costing
b. Variable costing
c. Fixed costing
d. Absorption costing
Quick Review Question #4

4. Which of the following lends itself well

to internal decision making?
a. Full costing
b. Variable costing
c. Absorption costing
d. None of these
Quick Review Answer #4

4. Which of the following lends itself well

to internal decision making?
a. Full costing
b. Variable costing
c. Absorption costing
d. None of these
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