9 - 1 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Inventory Costing and Capacity Analysis Chapter 9

9 - 2 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 1 Identify what distinguishes variable costing from absorption costing.

9 - 3 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Inventory-Costing Methods The difference between variable costing and absorption costing is based on the treatment of fixed manufacturing overhead.

9 - 4 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Variable Costing Direct Materials Variable Factory Labor Variable Overhead Work in Process Inventory

9 - 5 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Variable Costing Work in Process Inventory Finished Goods Inventory Cost of Goods Sold Income Summary Fixed Factory Labor

9 - 6 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 2 Prepare income statements under absorption costing and variable costing.

9 - 7 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Comparing Income Statements The following data pertain to Davenport Fixtures: Year 1Year 2 Total Beginning inventory -0- 2, Produced10,00011,50021,500 Sold 8,00013,00021,000 Ending inventory 2,

9 - 8 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Comparing Income Statements The following information is on a per unit basis: Sales price:$71.00 Variable manufacturing costs: Direct materials:$ 4.00 Direct manufacturing labor:$21.00 Indirect manufacturing costs:$24.00 Fixed manufacturing costs:$ 4.50

9 - 9 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Comparing Income Statements (Absorption Costing) Total fixed production costs are $54,000 at a normal capacity of 12,000 units. Fixed nonmanufacturing costs are $30,000 per year. Variable nonmanufacturing costs are $2.00 per unit sold.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Comparing Income Statements (Absorption Costing) Revenues$568,000 Cost of goods sold 428,000 Volume variance (U) 9,000 Gross margin$131,000 Nonmanufacturing costs 46,000 Operating income$ 85,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Comparing Income Statements (Absorption Costing) Revenues for Year 1 are $568,000. What is the cost of goods sold? 8,000 × $49 = $392,000 What is the manufacturing contribution margin? $568,000 – $392,000 = $176,000 Net contribution margin = $160,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Comparing Income Statements (Variable Costing) Revenues$568,000 Cost of goods sold 392,000 Variable nonmanufacturing costs 16,000 Contribution margin$160,000 Fixed manufacturing costs 54,000 Fixed nonmanufacturing costs 30,000 Operating income$ 76,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 3 Explain differences in operating income under absorption costing and variable costing.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Operating Income (Absorption Costing) What are revenues for Year 2? 13,000 × $71 = $923,000 What is the cost of goods sold? 13,000 × $53.50 = $695,500 Is there a volume variance? (12,000 – 11,500) × $4.50 = $2,250 underallocated fixed manufacturing costs

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Operating Income (Absorption Costing) What is the gross margin? $923,000 – ($695,500 + $2,250) = $225,250 What are the nonmanufacturing costs? 13,000 units sold × $2.00 = $26,000 variable costs + $30,000 fixed costs = $56,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Operating Income (Absorption Costing) What is the operating income before taxes? $225,250 – $56,000 = $169,250 What is the operating income for the two years combined? $85,000 + $169,250 = $254,250

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Income Statements (Absorption Costing) Year 1 Year 2 Combined Revenues$568,000 $923,000 $1,491,000 Cost of goods sold 428, ,500 1,123,500 Volume variance (U) 9,000 2,250 11,250 Gross margin$131,000 $225,250 $ 356,250 Nonmfg. costs 46,000 56, ,000 Operating income$ 85,000 $169,250 $ 254,250

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Operating Income (Variable Costing) Revenues for Year 2 are $923,000. What is the cost of goods sold? 13,000 × $49 = $637,000 What is the manufacturing contribution margin? $923,000 – $637,000 = $286,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Operating Income (Variable Costing) What is the net contribution margin? $286,000 – $26,000 variable nonmanufacturing costs = $260,000 net contribution margin What is the operating income before taxes? $260,000 – $54,000 fixed manufacturing costs – $30,000 fixed nonmanufacturing costs = $176,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Income Statements (Variable Costing) Year 1 Year 2 Combined Revenues$568,000$923,000$1,491,000 Cost of goods sold 392, ,000 1,029,000 Mfg. contr. margin$176,000$286,000$ 462,000 Variable nonmfg. 16,000 26,000 42,000 Net contr. margin$160,000$260,000$ 420,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Income Statements (Variable Costing) Year 1 Year 2Combined Net contr. margin$160,000$260,000$420,000 Fixed mfg. costs 54,000 54,000108,000 Fixed nonmfg. costs 30,000 30,000 60,000 Operating income$ 76,000$176,000$252,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Comparison of Variable and Absorption Costing Variable costing operating income Year 1: $76,000 Absorption costing operating income Year 1: $85,000 Absorption costing operating income is $9,000 higher. Why?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Comparison of Variable and Absorption Costing Production exceeds sales in Year 1. The 2,000 units in ending inventory are valued as follows: Absorption costing: 2,000 × $53.50 =$107,000 Variable costing: 2,000 × $49.00 =$ 98,000 Difference:$ 9,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Comparison of Variable and Absorption Costing Variable costing operating income Year 2: $176,000 Absorption costing operating income Year 2: $169,250 Variable costing operating income is $6,750 higher. Why?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Comparison of Variable and Absorption Costing Sales exceeded units produced in Year 2. 13,000 – 11,500 = 1,500 decrease in inventory Absorption costing: 1,500 × $53.50 = $80,250 Variable costing: 1,500 × $49.00 = $73,500 Higher cost of goods sold under absorption costing: $ 6,750

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Comparison of Variable and Absorption Costing Variable costing combined net income: $252,000 Absorption costing combined net income: $254,250 Absorption costing is higher by $2, units in inventory × $4.50 = $2,250

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Comparison of Variable and Absorption Costing Absorption costing operating income Variable costing operating income Fixed manufacturing costs in ending inventory under absorption costing Fixed manufacturing costs in beginning inventory under absorption costing – EQUALS –

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 4 Understand how absorption costing can provide undesirable incentives for managers to build up finished goods inventory.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Inventory Buildup What is the production volume variance? (12,000 – 4,400) × $4.50 = $34,200 U What is the net operating income or loss for the period? Assume that Davenport Fixtures produced 4,400 units in Year 1 and sold 4,100.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Inventory Buildup Revenues (4,100 × $71)$291,100 Cost of goods sold (4,100 × $53.50) 219,350 Volume variance 34,200 Gross margin$ 37,550 Nonmanufacturing costs 38,200 Net loss$ 650

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Inventory Buildup 4,400 – 4,100 = 300 How much cost is in ending inventory? 300 × $53.50 = $16,050 How many units are in ending inventory?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Inventory Buildup Sales remain the same (4,100 units). What is the volume variance? (12,000 – 9,000) × $4.50 = $13,500 U Suppose that management decides to produce 9,000 units next year. What is the operating income or loss?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Inventory Buildup Revenues (4,100 × $71)$291,100 Cost of goods sold (4,100 × $53.50) 219,350 Volume variance 13,500 Gross margin $ 58,250 Nonmanufacturing costs 38,200 Net income$ 20,050

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Inventory Buildup ,000 – 4,100 = 5,200 How much cost is in ending inventory? 5,200 × $53.50 = $278,200 How many units are in ending inventory?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 5 Differentiate throughput costing from variable costing and absorption costing.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Throughput Costing Revenues$568,000 Variable direct materials cost of goods sold 32,000 Throughput contribution margin$536,000 Manufacturing costs 504,000 Nonmanufacturing costs 46,000 Operating loss$ 14,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Throughput Costing Manufacturing Costs: Labor $21.00 × 10,000$210,000 Indirect costs $24.00 × 10, ,000 Fixed costs 54,000 Total manufacturing costs$504,000 What are other nonmanufacturing costs for the year?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Throughput Costing Nonmanufacturing Costs: Variable $2.00 × 8,000$16,000 Fixed 30,000 Total$46,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Throughput Costing Variable costing operating income:$76,000 Throughput costing operating loss:$14,000 Difference in operating income:$90,000 How can this difference be explained?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Throughput Costing The 2,000 units in ending inventory are valued as follows: Variable 2,000 × $49 = $98,000 Throughput 2,000 × $4 = $8,000 $90,000 difference

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Throughput Costing Absorption costing operating income:$85,000 Throughput costing operating loss:$14,000 Difference in operating income:$99,000 How can this difference be explained?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Throughput Costing The 2,000 units in ending inventory are valued as follows: Absorption 2,000 × $53.50 = $107,000 Throughput 2,000 × $4 = $8,000 $99,000 difference

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Comparison of Inventory Costing Methods Actual Costing Absorption Costing Absorption Costing Throughput Costing Throughput Costing Variable Costing Variable Costing

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Comparison of Inventory Costing Methods Normal Costing Absorption Costing Absorption Costing Throughput Costing Throughput Costing Variable Costing Variable Costing

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Comparison of Inventory Costing Methods Standard Costing Absorption Costing Absorption Costing Throughput Costing Throughput Costing Variable Costing Variable Costing

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 6 Describe the various capacity concepts that can be used in absorption costing.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Alternative Denominator-Level Concepts Theoretical capacity Practical capacity Normal capacity Master-budget capacity

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Budgeted Fixed Manufacturing Overhead Rate Lloyd’s Bicycles produces bicycle parts for domestic and foreign markets. Fixed overhead costs are $200,000 within the relevant range of the various capacity volume.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Budgeted Fixed Manufacturing Overhead Rate Assume that the theoretical capacity is 10,000 machine-hours, practical capacity is 85%, normal capacity is 75%, and master-budget capacity is 60%. What is the budgeted fixed manufacturing overhead rate at the various capacity levels?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Budgeted Fixed Manufacturing Overhead Rate Theoretical 100%: $200,000 ÷ 10,000 = $20.00/machine-hour Practical 85%: $200,000 ÷ 8,500 = $23.53/machine-hour Normal 75%: $200,000 ÷ 7,500 = $26.67/machine-hour Master-budget 60%: $200,000 ÷ 6,000 = $33.33/machine-hour

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 7 Understand the major factors management considers in choosing a capacity level to compute the budgeted fixed overhead cost rate.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Choosing a Capacity Level What factors are considered in choosing a capacity level? Product costing Pricing decision Performance evaluation Financial statements Regulatory requirements Difficulty

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Decision Making Assume that Lloyd’s Bicycles’ standard hours are 2 hours per unit. What is the budgeted fixed manufacturing overhead cost per unit?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Decision Making Theoretical capacity: $20 × 2 = $40.00 Practical capacity: $23.53 × 2 = $47.06 Normal capacity: $26.67 × 2 = $53.34 Master-budget capacity: $33.33 × 2 = $66.66

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 8 Describe how attempts to recover fixed costs of capacity may lead to price increases and lower demand.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Downward Demand Spiral The downward demand spiral is the continuing reduction in demand that occurs when the prices of competitors are not met and demand drops.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Learning Objective 9 Explain how the capacity level chosen to calculate the budgeted fixed overhead cost rate affects the production-volume variance.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Effect on Financial Statements Assume that Lloyd’s Bicycles actually used 8,400 machine-hours during the year. What is the production volume variance?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Production Volume Variance Production volume variance = (Denominator level – Actual level) × Budgeted fixed manufacturing overhead rate Theoretical capacity: (10,000 – 8,400) × $20.00 = $32,000 U Practical capacity: (8,500 – 8,400) × $23.53 = $2,353 U

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster Production Volume Variance Normal capacity: (7,500 – 8,400) × $26.67 = $24,003 Master-budget capacity: (6,000 – 8,400) × $33.33 = $79,992

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster End of Chapter 9