Variable Costing: A Tool for Management Chapter 7

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Overview of Absorption and Variable Costing

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Harvey Co. produces a single product with the following information available: Unit Cost Computations

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Unit product cost is determined as follows: Selling and administrative expenses are always treated as period expenses and deducted from revenue. Unit Cost Computations

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Harvey Co. had no beginning inventory, produced 25,000 units and sold 20,000 units this year. Income Comparison of Absorption and Variable Costing

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Harvey Co. had no beginning inventory, produced 25,000 units and sold 20,000 units this year. Income Comparison of Absorption and Variable Costing

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Now let’s look at variable costing by Harvey Co. Income Comparison of Absorption and Variable Costing Variable costs only. All fixed manufacturing overhead is expensed.

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Let’s compare the methods. Income Comparison of Absorption and Variable Costing

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Let’s compare the methods. Income Comparison of Absorption and Variable Costing

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Reconciliation Fixed mfg. overhead $150,000 Units produced 25,000 = = $6.00 per unit We can reconcile the difference between absorption and variable income as follows:

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill 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.

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Harvey Co. Year 2 Unit product cost is determined as follows: No change in Harvey’s cost structure.

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Harvey Co. Year 2 These are the 25,000 units produced in the current period.

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Harvey Co. Year 2 Variable costs only. All fixed manufacturing overhead is expensed.

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Let’s compare the methods. Income Comparison of Absorption and Variable Costing

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Reconciliation Fixed mfg. overhead $150,000 Units produced 25,000 = = $6.00 per unit We can reconcile the difference between absorption and variable income as follows:

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Summary

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Summary

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Variable versus Absorption Costing Fixed costs are not really the costs of any particular product. All manufacturing costs must be assigned to products to properly match revenues and costs. Absorption Costing Variable Costing

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Variable versus Absorption Costing Depreciation, taxes, insurance and salaries are just as essential to products as variable costs. Absorption Costing Variable Costing These are capacity costs and will be incurred if nothing is produced.

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Advantages of the Contribution Approach Advantages Management finds it easy to understand. Consistent with CVP analysis. Net income is closer to net cash flow. Profit is not affected by changes in inventories. Impact of fixed costs on profits emphasized. Consistent with standard costs and flexible budgeting. Easier to estimate profitability of products and segments.

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill Impact of JIT Inventory Methods In a JIT inventory system... Production tends to equal sales... So, the difference between variable and absorption income tends to disappear.

© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw-Hill End of Chapter 7