Segment Reporting and Performance Evaluation CHAPTER Segment Reporting and Performance Evaluation

After studying this chapter, you should be able to: Objectives 1. Discuss the differences between variable and absorption costing. 2. Explain how variable costing is useful in evaluating the performance of a manager. 3. Prepare a segmented income statement based on a variable-costing approach, and demonstrate how to use this format with activity-based costing to assess customer profitability. After studying this chapter, you should be able to:

Objectives 4. Show how variable costing can be used in planning and control.

Variable costing assigns only variable manufacturing costs to the product. Direct materials Direct labor Variable overhead

Absorption costing assigns all manufacturing costs to the product; this adds fixed overhead to the formula. Direct materials Direct labor Variable overhead Fixed overhead

Inventory Valuation Units in beginning inventory --- Units produced 10,000 Units sold ($300 each) 8,000 Normal volume 10,000 Fixed costs: Fixed overhead $250,000 Fixed selling and administrative 100,000 Variable cost per unit: Direct materials $ 50 Direct labor 100 Variable overhead 50 Variable selling and administrative 10

Unit Cost Variable Absorption costing costing Direct materials $ 50 $ 50 Direct labor 100 100 Variable overhead 50 50 Fixed overhead 25 $250,000 10,000

Unit Cost Variable Absorption costing costing Direct materials $ 50 $ 50 Direct labor 100 100 Variable overhead 50 50 Fixed overhead 25 Total $200 $225

Variable-Costing Income Statement Fairchild Company Variable-Costing Income Statement Sales $2,400,000 Less variable expenses: Variable cost of goods sold $1,600,000 Variable selling and admin. 80,000 1,680,000 Contribution margin $ 720,000 Less fixed expenses: Fixed overhead $ 250,000 Fixed selling and admin. 150,000 350,000 Net income $ 370,000

Absorption-Costing Income Statement Fairchild Company Absorption-Costing Income Statement Sales $2,400,000 Less: Cost of goods sold 1,800,000 Gross margin $ 600,000 Less: Selling and administrative exp. 180,000 Net income $ 420,000 Variable costing net income $370,000 Fixed portion of ending inventory (2,000 units x $25) 50,000 Absorption costing net income $420,000

Production, Sales, and Income Relationships If Then Production > Sales Absorption NI > Variable NI Production < Sales Absorption NI < Variable NI Production = Sales Absorption NI = Variable NI 8 8

Data for Belnip, Inc., for years 2002, 2003, and 2004 follows: Example Data for Belnip, Inc., for years 2002, 2003, and 2004 follows: Variable cost pr unit: Direct materials $4.00 Direct labor 1.50 Variable overhead (estimated and actual) 0.50 Variable selling and administrative 0.25 Estimated fixed overhead was $150,000 each year. Normal production was 150,000 units and the sales price was $10. Fixed selling and administrative expenses were $50,000.

Variable-Costing Income Statement 2002 2003 2004 Sales Less variable expenses: Variable cost of goods sold Variable selling and admin. Contribution margin Less fixed expenses: Fixed overhead Fixed selling and admin. Net income $1,500.00 -900.00 -87.50 $ 562.50 -150.00 -0.50 $ 367.50 $1,000 -600 -25 $ 375 -150 -50 $ 367 $2,000 -1,200 -50 $ 750 -150 $ 550 BI $ 300 Cost of GM 900 GAFS $1,200 Less: EI 0 VCof GS $1,200 BI $ 0 Cost of GM 900 GAFS $900 Less: EI 0 VCof GS $900 BI $ 0 Cost of GM 900 GAFS $900 Less: EI 300 VCof GS $600

Absorption-Costing Income Statement 2002 2003 2004 BI $ 350 Cost of GM 1,050 GAFS $1,400 Less: EI 0 Cof GS $1,400 Sales Less: Cost of goods sold Gross margin Less: Selling and admin. exp. Net income $1,500.00 -1,050.00 $ 450.00 87.50 $ 362.50 $1,000 700 $ 300 75 $ 225 $2,000 1,400 $ 600 100 $ 500 BI $ 0 Cost of GM 1,050 GAFS $1,050 Less: EI 0 Cof GS $1,050 BI $ 0 Cost of GM 1,050 GAFS $1,050 Less: EI 350 Cof GS $ 700

Absorption costing income – Variable costing income = Fixed overhead x (Units produced – Units sold) 2004 $500,000 – $550,000 = $1 x (150,000 – 200,000)

If income performance is expected to reflect managerial performance, then managers have the right to expect-- As sales revenue increases from one period to the next, all other things being equal, income should increase. As sales revenue decreases from one period to the next, all other things being equal, income should decrease. As sales revenue remains unchanged from one period to the next, all other things being equal, income should remain unchanged.

Absorption-Costing Basis Segment Reporting Elcom, Inc. Income Statement, 2004 Absorption-Costing Basis Stereos Video Recorders Total Sales $400,000 $290,000 $690,000 Less: Cost of goods sold 350,000 300,000 650,000 Gross margin $ 50,000 $ -10,000 $ 40,000 Less: Selling and administrative exp. 30,000 20,000 50,000 Net income or loss $ 20,000 $ -30,000 $ -10,000

Variable-Costing Basis Elcom, Inc. Income Statement, 2004 Variable-Costing Basis Stereos Video Recorders Total Sales $400,000 $290,000 $690,000 Less variable expenses: Variable C of GS -300,000 -200,000 -500,000 Variable S & A -5,000 -10,000 -15,000 Contribution margin $ 95,000 $ 80,000 $175,000 Less direct fixed exp.: Direct fixed overhead -30,000 -20,000 -50,000 Direct S & A -10,000 -5,000 -15,000 Segment margin $ 55,000 $ 55,000 $110,000 Less common fixed exp.: Common fixed OH -100,000 Common S & A -20,000 Net income or loss $-10,000

Barton, Inc. Profit for Chain Stores Sales $4,725,000 Less: Discounts 393,750 Net sales $4,331,250 Less: Cost of goods sold 2,520,000 Gross profit $1,811,250 Less: Shelf space -112,500 Shipping -157,500 EDI -100,000 Profit $1,441,250

Barton, Inc. Independent Toy Stores Profit for Sales $2,625,000 Less: Cost of goods sold 1,400,000 Gross profit $1,225,000 Less: Commissions -131,250 Special packaging -35,000 Profit $1,058,750

Barton, Inc. Profit for Fairs Sales $150,000 Less: Cost of goods sold 80,000 Gross profit $ 70,000 Less: Fair expense -75,000 Design time -2,100 Setup -1,000 Loss $ -8,100

Chapter Fifteen The End