INCOME EFFECTS OF ALTERNATIVE INVENTORY-COSTING METHODS

Variable Costing & Absorption Costing A method of inventory costing in which all variable manufacturing costs are included as inventoriable costs Absorption Costing A method of inventory costing in which all variable manufacturing costs and all fixed manufacturing costs are included as inventoriable costs

Radius Company for 20_7 The budgeted number and actual number of units produced are equal (1,100,000 units). The budgeted number and actual number of units sold are equal (1,000,000 units). The budgeted and actual fixed costs are equal. Work in process is minimal. No beginning inventory on January 1, 20_7. All variable costs are driven by an output-unit-related variables.

Radius Company for 20_7

Income Statement for the Radius Company(20_7)

Income Statement for the Radius Company(19_7)

Comparison of Standard Variable Costing and Standard Absorption Costing The Stassen Company Unit data Beginning inventory Production Sales Ending inventory January 20_7 600 400 200 February 20_7 200 650 750 100 Selling Price $99 Standard variable manufacturing costs per unit $20 Standard variable marketing costs per unit $19 Standard fixed manufacturing costs per month $12,800 Standard fixed marketing costs per month $10,400 Budgeted denominator level of production per month 800 output units

Income Statement for the Stassen Company(20_7)

Income Statement for the Stassen Company(19_7)

Explaining Differences in Operating Income Absorption costing Variable costing Difference Jan. 20_7 $4,000 $800 $3,200 Feb. 20_7 $20,200 $21,800 $(1,600) Formula 1 Absorption-costing operating income Variable-costing operating income Fixed manufacturing costs in ending inventory Fixed manufacturing costs in beginning inventory - = - January 20_7 $4,000 - $800 = (200$16) - (0 $16) = $3,200 February 20_7 $20,200 - $21,800 = (100$16) - (200 $16) = -$1,600

Explaining Differences in Operating Income ASSUMPTIONS 1. All manufacturing variances are written off as period costs 2. No change occurs in work in process inventory 3. No change occurs in the budgeted fixed manufacturing overhead rate between accounting periods Formula 2 Absorption-costing operating income Variable-costing operating income Budget fixed manufacturing costs rate - - Units produced Units sold =  January 20_7 $4,000 - $800 = (600 - 400)  $16 = $3,200 February 20_7 $20,200 - $21,800 = (650 - 750)  $16 = -$1,600

Effect of Sales and Production on Operating Income

Comparative Income Effects of Variable Costing and Absorption Costing

Throughput Costing Throughput costing (also called super-variable costing ) treats all costs except those related to variable direct materials as costs of the period in which they are incurred; only variable direct materials costs are inventoriable.

Capsule Comparison of Alternative Inventory-Costing Systems Throughput costing Variable costing Absorption costing

Performance Measures and Absorption Costing Undesirable Buildups of Inventories Absorption costing enables managers to increase operating income in the short run by increasing the production schedule independent of customer demand for products Proposals for Revising Performance Evaluation 1. Change the accounting system. 2. Change the time period used to evaluate performance. 3. Include nonfinancial as well as financial variables in the measures used to evaluate performance.

Company Usage of Variable Costing S U R V E Y S OF C O M P A N Y P R A C T I C E Company Usage of Variable Costing Variable costing used Absorption costing Other 31% 65 4 48% 52 33% 67 31% 69 42% 58 52% 48 Prorate fixed MOH to inventory /cost of goods sold at period end Use variable costing to monthly costing, and convert to absorption costing once a year Use of variable costing and absorption costing as dual systems Treat fixed MOH as a period cost Other 41% 11 23 25 39% 8 33 3 17 25% 4 31 35